Mercantile (MRC) investment trust fund manager Guy Anderson responds to investors' concerns that stock markets look frothy after the remarkable rebound since the pandemic crash over a year ago. This is the third excerpt from Anderson's 'Great British Companies - from Crisis to Recovery' presentation at a Citywire virtual event last week. Previous excerpts covered why Anderson is bullish about the UK's consumer and manufacturing recovery and the 'mid cap' stocks he believes will benefit.
If these whet your appetite, you can watch the entire 54-minute recording here.
Can't watch now? Read the transcript
Andrew Moffatt asks: 'How worried are you in the recent rise in bond yields and as well as that, the high valuations in equity markets, globally, by any number of metrics?' And we've got other people referring to frothy markets and whether you think they're running ahead of earnings. How worried are you that we're due a pullback? Guy Anderson:
That's an excellent question because it's a very valid thing for us to be concerned about. Before I give my answer, I think it's worth saying first of all, there will be a pullback at some point because markets do not go up in a linear manner, forever.
The challenge, of course, is knowing when the pullback will come and how significant the pullback will be. Of course, as we don't have perfect foresight, we cannot possibly answer that, but it is inevitable. It is worth putting that out there and I think the rise in bond yields is absolutely-, and the threat of inflation is something that's been occupying the market's mind a bit more recently, absolutely, bring that front and centre to everyone's attention.
In terms of valuation, I don't usually rely on a cyclically-adjusted P/E [CAPE], but I am going to refer to it today. The reason that I'm going to refer to it is actually, usually, I think about what is the valuation of the market for this year, on a straightforward P/E [price-earnings] basis because it's the easiest for everyone to understand, but actually, we're at a point where current year earnings, it's not that they're meaningless, but given some of the restrictions, they are a less relevant datapoint than would often be the case. Actually, if we look at a cyclically adjusted P/E, which is really just taking the earnings over the last ten years, the UK is still on around 12 times and is at a quite substantial discount to Europe, a 20%-plus discount or 20%-ish discount and those are markets that usually trade quite closely in line.
Of course, there's different sectoral mixes, but actually, they have pretty similar growth and quality characteristics over the long-term. So, I think the UK is at a discount to other markets. When looking at the US, the US is clearly much higher-, on a much higher rating than both Europe and the UK and that is something that potentially, might give pause for thought, but I'm not the US expert so, I'm not going to profess to be.
When I think about the UK, I actually don't think the valuations are that extended, particularly given I think it's important to note that we're at a point where we are seeing improving expectations. So, by that I mean, we're seeing upgrades to economic growth expectations and at a micro level, at a company level, we are seeing a far higher number of upgrades to expectations than we are seeing downgrades. In other words, I believe that expectations in the market, today, are actually more conservative than the eventual outcome.
So, valuations as seen on the screen today, are actually, more expensive-, the valuations on the screen are more expensive than they are in reality.