Investment Solutions warns equity markets now ‘irrationally optimistic’

SA’s leading provider of multi-manager investment portfolios has warned that equity markets globally are in risky territory - despite recent gains and significantly reduced volatility.

Glenn Silverman, Global Chief Investment Officer of Investment Solutions, said today that many countries, and particularly the US and the UK, are still in deep economic trouble.

“The debt and leverage excesses within the system, allied with typically low savings rates, are expected to create a massive headwind against which global economic growth, and presumably equity markets, may struggle for years to come.”

Silverman cautioned that the recent global equity market rally which started in early March this year is simply a rally within a longer-term bear market and is likely to be unsustainable.

“Markets may well still grind higher over the next few weeks but investors should note that markets are approaching an over-bought level. And the historically dangerous month of October is only 9 weeks away.

“Investors should avoid chasing the market at this late stage. The bear is still lurking out there somewhere.”

Since March 9th when global equity markets bottomed, the JSE has rallied over 30% in Rand terms, but a far more impressive 81% in US dollars. Over the same period, the S&P 500 has notched up gains of 45% while China is up 62% in their local currency.

“Just as global investors panicked-out of markets last year, they have been panicking-in this year, for fear of losing out on the possible start of a new bull trend. Record low short-term cash rates have contributed as people are earning very little by having money in the bank.”

Silverman notes that if irrational pessimism was to be found during the dramatic market falls to March this year, then there may be signs of some irrational optimism right now.

Silverman points to S&P500 headline earnings per share ( including all write-offs) of $7, implying a price/earnings (PE) ratio of around 139 times, at the current S&P 500 level of around 970, as evidence that that market may be getting ahead of itself.

Even using current operating earnings per share of around $60, still gives a PE of 16 times, with the true sustainable earnings per share level likely somewhere between the two.

“These are not typically the PE levels associated with the start of a long-term bull market as they are too high,” he adds.

“One would expect Western equity markets to command a lower PE ratio rating, for the next decade considering the expected lower growth, higher risks and the barely-started deleveraging cycle.”

Silverman said that while the outlook is more positive for emerging markets, they too have rallied sharply driven by huge investor inflows and a return of risk appetite.

“In SA, share prices have continued to rise, notwithstanding the worsening economic and corporate news. The market has re-rated and the risks of a reversal have clearly increased.

“Markets are always forward looking and discounting what is expected to be better news in both the local and economy in say 12 to 15 months time, but it may just have gone to far.”