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Bargains getting harder to find

Despite its higher GDP growth, China's valuations are at a significant discount to the US at approximately 13x forward P/E for MSCI China versus 18x P/E for the S&P 500.

WE'RE in the second-longest bull market since World War II, surpassed only by the decade-long bull run that flamed out dramatically in 2000 in what's now known as the dotcom bust.

Since hitting a closing low of 676.53 in the depths of recession on March 9, 2009, the S&P 500 index has rallied 250 per cent. Keeping in mind that the average bull market lasts 57 months, the gains since - uninterrupted by a decline of 20 per cent or more - have investors understandably wondering if this bull run might live to celebrate its ninth birthday.

With the S&P 500 trailing the 12-month P/E ratio at 22x (the long-term average is around 17x), this is also the second-most expensive bull market. For comparison, the S&P was trading at a multiple of around 30x earnings when the tech bubble burst.


Market voices on:

Market optimists assert that markets don't pay attention to the calendar or die of old age, preferring to focus on fundamentals that they believe can support current valuations, albeit elevated.

The global economic environment remains positive for equities. Global gross domestic product (GDP) growth accelerated to 3.5 per cent in the first quarter of 2017 and could approach 4 per cent by the beginning of 2018. Activity metrics such as the Purchasing Managers Indexes (PMIs) also point to a somewhat synchronised expansion across the United States, Europe and emerging markets for the first time in more than a decade.

Buoyed by stronger global growth, corporate earnings estimates are also rising, creating fundamental support for risk assets. Analysts are estimating a 14 per cent rise in FY17 earnings for the S&P 500 companies from a year earlier. The positive earnings revisions across the major markets globally since the start of the year is something not seen for the past several years.

Then there is the "Trump rally", built on hopes of massive tax cuts and fiscal spending that could accelerate economic growth and stimulate corporate profits - though there are growing doubts about the US president's ability to push through these policies, following the recent setback to his healthcare bill and other political controversies.


While the market hasn't yet given any signs of reversing this long uptrend, Q2 earnings would be closely watched to see if the high valuations, particularly in the US market, are justified. The outlook for equities for the rest of 2017 will depend heavily on the delivery of corporate earnings expectations.

Market observers are also keeping a keen eye on global central banks who, with the exception of the Bank of Japan, have signalled a gradual shift away from historically unprecedented monetary easing, as economic data have started to be supportive of rising interest rates and monetary tightening. Given the large amount of debt created in the system post the global financial crisis, this will prove to be a delicate operation.

Any policy misstep by the US Federal Reserve or the European Central Bank in this aspect could result in turmoil in both the stock and bond markets. Unforeseen geopolitical events, particularly in the Middle East and the Korean Peninsula, could also potentially derail the bull market.


Despite these risks, expectations of rising inflation, recovery in global trade and corporate capex, and continued improvements in key global economic indicators will create an environment that is favourable for equities among other asset classes.

While it's vital to stay nimble and monitor key event risks, investors should do well positioning themselves in equities, particularly across the following investment themes that we see shaping the second half of this year and beyond.

Rotation into Europe, China and Asia

Relative to the US, valuations in Europe and Asian markets are relatively favourable. The forward 2017 P/E for Europe is currently at 15x, representing a discount of 17 per cent compared to US stocks (as measured by the S&P 500's forward P/E of 18x). As the European economies pick up steam, global reflation and an improving earnings outlook should support cyclical and export-oriented companies, particularly industrials and multinationals with EM exposures.

Meanwhile, equity valuations in Asia remain reasonable and offer good fundamental, bottom-up stock-picking opportunities for investors.

Take for instance China, Asia's largest economy and second-largest globally after the US. Its GDP growth of 6.6 per cent is far outpacing that of the US at 2.2 per cent. Despite the higher growth, China's valuations are at a significant discount to the US at approximately 13x forward P/E for MSCI China versus 18x P/E for the S&P 500.

Over the next decade, Asia, along with other emerging markets, will be among the key drivers of global economic expansion driven by rising consumption, technological and industrial transition.

Banking on the banks

As global central banks look to gradually raise interest rates, we see opportunities particularly in the financial sector. History suggests that the early phases of a rising rate cycle is positive for equity markets in general and interest-rate sensitive sectors like financials will benefit from a rising rate environment boosting net interest margins and trading income.

Moreover, the banking sector may potentially enjoy lower operating and regulatory costs should the Donald Trump administration succeed at easing banking regulations which have been stifling profits and ROEs. The cyclical recovery in sectors like technology, industrials, healthcare and materials also help boost overall capex and investments, which generally bode well for corporate lending activities.

On the flip side, investors should stay cautious of highly-geared companies or sectors that rely on financial engineering and cheap funding to generate returns such as Reits, business trusts etc. Instead, one should focus on quality growth companies with sustainable competitive advantage, above-average returns on capital, and reasonable valuations for long-term outperformance.

The digital revolution

Hailed as the "Fourth Industrial Revolution", technology will provide investment opportunities over the long term. A nascent trend that seeks to provide intelligence and connectivity to everyday consumer and industrial devices, the Internet of Things (IoT) is reshaping the business dynamics of multiple industries. Examples include self-driving (autonomous) vehicles, mobile payment systems, wearable devices and robotics, virtual as well as augmented reality technologies. This will benefit vendors in chip design, software, and semiconductor and other component-related sectors. Other sectors to consider with the explosion of data are cybersecurity and data waste management.


At the end of the day, no one can know for sure when the bull market will end. But what we can agree on is that in an ageing bull market, it gets increasingly harder to find bargains as the risk-return trade-off becomes less attractive. As market valuations become extended, even greater emphasis should be placed on bottom-up analysis to ensure that each individual equity investment not only has the right business fundamentals to ride out the next economic downturn, but is also reasonably valued to ensure a sufficient margin of safety to face the bear when it finally rears its ugly head.

  • The writer is the founder and CEO of Thirdrock Group, an award-winning investment and wealth management firm based in Singapore