S&P: Nothing to Fear But Fear Itself
01/19/2007 12:00 am EST
Some market pundits have recently expressed concern about too much complacency among investors, but Standard & Poor's strategist Alec Young, writing in the weekly outlook, sees solid fundamentals and reasonable valuations in stock markets worldwide...
"Financial markets are driven by what John Maynard Keynes called "animal spirits," the most powerful being fear and greed. One widely tracked gauge of fear is the CBOE Volatility Index, or VIX, which measures the market's expectations for near-term volatility as conveyed by Standard & Poor's 500 index option prices. Currently, the VIX is trading at multi-year lows, suggesting that fear is in deep hibernation. But when combined with the strength in global markets over the past three years, many market participants are concerned that the complacency implied by the VIX is spreading, leaving global stock markets vulnerable.
"Not likely. We believe the reason for the complacency is the fact that equity fundamentals are, in a word, excellent. Liquidity is ample and inflation is low, both of which serve to depress interest rates and fuel unprecedented global M&A activity. At the same time, attractive 2007 growth prospects and low P/E-to-growth ratios are lending important valuation support to global stock markets. Global equity valuations are historically low, especially given healthy 2007 earnings expectations. Despite a consensus 2007 earnings growth projection of 9%, above the historical average, the S&P Global 1200 index is currently trading at a P/E of only 14.6x [projected 2007 earnings], a 12% discount to its long-term average of 16.5x.
"We believe conservative valuations reflect fears of a US economic recession. However, increasing domestic demand in Europe, Japan, and key emerging markets (accounting for 50% of global GDP growth) is creating a macroeconomic landscape wherein the world is less dependent on exports to the US to maintain a healthy expansion. In addition, fears of a US slowdown have been widely telegraphed and are now fully discounted, we believe. As a result, we believe consensus 2007 global GDP and profit growth estimates are achievable and should enable continued strong equity performance.
"We do not believe that any deterioration in these fundamentals is nigh. Modest portfolio rebalancing is certainly appropriate in light of recent gains. But given the difficulty of successfully timing the market--requiring both a graceful exit at the top and a cool reentry at the bottom--S&P does not currently advise significantly reducing equity exposure.
"We recommend staying with a 60% equity allocation that dedicates 40% to US stocks--34% in large-cap, 4% in mid-cap, and 2% in small-cap issues. We also advise a 20% international equity allocation, with 15% in developed markets and 5% in emerging markets."