Equities have entered a new paradigm as a function of the pandemic with valuations and real yields reaching levels we have not seen in recent history. Profit margins are at all-time highs in the US while commodities are close to new all-time highs. At the same time the UN’s food price index is already flirting with the highest levels in six decades and Europe is at the cusp of an energy shock. The delta variant has caused global growth to slow and added more bottlenecks across manufacturing hubs in Asia. For now equities are shrugging it all off, with the second-longest rally with a drawdown of 5% or less since 1999.
Meanwhile capital expenditure in the mining and energy sectors is historically low, the developed world is doing an accelerated decarbonisation, excessive ESG focus is increasing costs for companies, and global manufacturing is being reconfigured creating a less smooth supply side in the global economy. Rewind the clock 10 years and nobody would have thought these factors could coincide, but now they are. The big question is whether it is a sustainable equilibrium, or we are at the turning point of a bigger reset in financial markets?
Global equity valuations—especially US equity valuations—are at absolute highs measured across a wide range of valuation metrics. The current valuation level is associated historically with a very low probability of a positive real rate return over the next 10 years. In isolation it looks like another terrible inflated bubble in equities, but unlike the dot com bubble where the alternative was high real yields this time investors are offered no meaningful yield in bonds; in essence we have maxed out the wealth effect. It seems investors are willing to take a bet that, even at these elevated valuations, the future return will still be better than that of the bond alternatives.
Source : Bloomberg & Saxo
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