Last updated: 06:22 / Friday, 10 October 2014
Research by Allianz GI

Irrational Exuberance 2.0?

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Irrational Exuberance 2.0?
  • Global equities look roughly fairly priced and in line with long-term average multiples
  • European equities, especially 
in the periphery, even look cheap. The same applies to Emerging Market Equities
  • US equities today are undoubtedly at high multiples compared to their own history
  • The valuation assessment today is less favorable for corporate bonds
  • Emerging market bonds issued in hard currencies are reasonably priced, according to Allianz GI’s report

The warning signs of new asset bubbles are growing almost by the day. Major institutions, like the International Monetary Fund (IMF) and the Bank for Internatinal Settlement (BIS), as well as individuals who have been right at pointing out bubbles in the past – such as Raghuram Rajan, Governor of the Reserve Bank of India, who correctly anticipated the US real estate bubble – have all started issuing words of warning.

Stefan Hofrichter, CFA, Head of Global Economics & Strategy at Allianz Global Investors, has written a report which was discussed in Allianz GI Investment Forum in Frankfurt last month where he addresses the following issue:

Are we currently witnessing the creation of a new asset bubble or, even worse, a series of asset bubbles fuelled by ultra-easy monetary policy?

The debate should not come as a surprise: US equities were just a few percentage points off their record highs as of the day of writing the report, and other major equity markets have reached all-time highs or multiyear highs over the course of 2014. Bond spreads – be it corporate bonds, emerging market bonds or euro-zone sovereign bonds – are tight by historical standards, albeit not at historical lows. In addition, real estate prices have rebounded forcefully over the past few years in the US, the UK and several euro-area countries. House prices have risen, especially in countries that did not suffer from the burst of a debt-financed real estate bubble at the end of the last decade. This is particularly true for China, other major emerging markets – like Turkey, Brazil and India – and several industrialized markets, notably Hong Kong, Singapore, Canada, Norway, Sweden and Israel. Allianz GI therefore thinks it makes sense to update its research on asset valuation and asset bubbles.

You may access the complete report through this link, though, these are some of the conclusions:

EQUITIES: Based on the cyclically adjusted price-earnings ratio (“CAPE”), also known as “Shiller PE”, global equities look roughly fairly priced and in line with long-term average multiples. European equities, especially 
in the periphery, even look cheap on this metric. The same holds true for emerging market equities, which are again trading at a discount of around 20 % compared to equities from industrialized countries and are at their lowest valuation reading since
 2006 – and at a similar discount as they were in the mid-1980s.

While US equities today are undoubtedly at high multiples compared to their own history, valuations are not in bubble territory and do not preclude a further rise in stock prices. Current valuations are no reason to become ultra- cautious on equities at this juncture, even though current valuations are likely to imply below-average real returns in the coming decade if past experience is a guide for future developments.

BONDS: High-quality sovereign bonds, such as US Treasuries, UK Gilts and German Bunds, are trading significantly below what Allianz GI thinks are nominal trend GDP growth rates, which should be the long-term reference value, based on both economic theory and past experience. Nevertheless, Allianz GI is more relaxed about the valuation of non-German euro-area sovereign bonds relative to Bunds.

Compared to the beginning of the year, though, the valuation assessment today is less favorable for corporate bonds, even though spreads compared
to sovereigns are higher today than they were just before the burst of the real estate bubble. This statement is particularly true for high-yield bonds, be it in the US or Europe.

Emerging market bonds issued in hard currencies (benchmark: EMBI+) are reasonably priced, according to Allianz GI’s report. Still, the manager finds that local currency bonds offer better value: first, because of the higher yields compared to sovereign bonds from developed markets; and second, because they also expect additional gains from currencies, which look undervalued in the calculations based on Allianz GI’s long-term valuation approaches.

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