David Stevenson: Shares go into freefall

Friday 24 October, 2008

A funny thing happened yesterday. Shares carried on falling, small caps and emerging markets stocks continued to experience their awful beating but the cheerleader of the perma-bears, a certain Albert Edwards over at SocGen brought out a note with the following shocking conclusions.

It said: “We are increasing our equity exposure significantly for both tactical and strategic reasons. The recent plunge in equities has brought valuations to levels that even trenchant bears such as us might say that equities are cheap in Europe.”

My first reaction was that this was some kind of very belated April Fools Joke – surely the man who prophesised the FTSE 100 at 3000, didn’t really believe that the current depressed markets are the end of the matter. Well, the answer to this longer term question, ‘is this actually a market bottom?’, is a slightly more nuanced yes and no. The yes bit is contained in the graph which shows a crucial measure of valuation, namely something called the cyclically adjusted price to earnings ratio. Like Edwards at SocGen I use it all the time as it tells you what the longer trend of earnings really is – for many years its been far too high for deep value investors but in recent weeks, in Europe at least, that measure has slumped dramatically. We are now closing in valuations not seen for thirty years. So, yes, valuations in Europe are cheap.

Now the ‘no’ bit of the answer, the nasty coda that suggests we are not quite yet at the bottom. Edwards also points out that the US markets are still not at decent valuations – cyclically adjusted valuations are still in the low teens. I sense that there’s at least another 25 per cent to come off the US markets, bringing that key measure back into single figures. That continuing fall will weigh down heavily on all global markets, which as we all now know are auto-correlated (because of sentiment if nothing else). So European equities might, like Japanese stocks, overshoot and get too cheap, presenting us with unprecedented long term buying opportunities, but that time has not come yet.

David Stevenson is also one of the Four Wise Monkeys at the online TV investment programme www.4wm.co.uk


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