Global Equities: a progress check on that "Generational Buying Opportunity"​

The purpose of this blog post is to provide a progress check and update on that controversial (at the time) "Global Equities: A Generational Buying Opportunity Emerging" post from March last year (where I laid out the bull case).

It also gives me a chance to outline the framework and thinking in seeing that initial analysis to its logical conclusion...

Specifically, what I mean by that is: it's one thing to come up with an idea, it's another thing to see that idea through its natural lifecycle.

In other words, a "buy" eventually becomes a "sell" - but as we will see, there is also that in-between-space... not to preempt the conclusion, but the part where it's a matter of saying "stay the course" and pay close attention to the key signposts along the road.

With that in mind, let's get into the charts!

1. Market Breadth: Meltdown to Meltup

The proportion of countries with positive year over year returns went almost all the way to zero this time last year... naturally that creates a very low bar in terms of base comparator, so it was always going to be 'easy' for this one to come roaring back. But along the way it did pass through that blue line I've drawn on the chart: which from a bull market detection perspective is a fairly reliable medium-term signal.

What to watch for: The time to get concerned will be when this indicator rolls over, and specifically when it passes back below the blue line. Until then it's a fairly clear bullish medium-term signal for global equities.

2. Valuation Breadth: Most Countries *were* Cheap...

Applying market breadth analysis to valuations, this time last year we briefly saw just over 70% of countries fall into the "cheap" category (somewhat arbitrarily defined as trading on a PE10 ratio below 15x), while the proportion of countries in the "expensive" category fell to 0%. From a valuation standpoint that's about as clear as it gets. Things have clearly snapped back now, but as of the time of writing, while 20% are now "expensive", 24% of countries are still in the cheap category.

What to watch for: There are definitely pockets of overvaluation, but this chart shows how it is not a widespread issue. We shouldn't be worried about valuations at the global level until that red line climbs further (and/or the green line drops further).

3. PE10 Valuations: no longer cheap

Before I get into this chart, I want to emphasize why I chose to focus on the PE10 ratio: it became very obvious to me early on that the pandemic shock would cause wild gyrations in trailing and forward earnings and thus render the trailing 12m and forward PE ratios useless. The PE10 is basically designed specifically for this type of scenario - by using trailing 10 year average earnings you have a more stable anchor to base valuation judgements on. I point that out because I received a lot of pushback at the time on my assertion that valuations looked objectively cheap (with EM equities back to 2003 levels, and developed markets back to 2009 levels).

But in terms of where we are now, there is nuance: the US is clearly expensive, the rest of the world is no longer cheap, but still reasonable vs long-term history and vs the US.

What to watch for: At this point admittedly we need to pay more attention to the equity risk premium (i.e. factoring in changes in bond yields aka the relative opportunity set). But with regards to this chart, it lays out the compelling relative value case for global ex-US. The other thing will be to take note of any further upside overshoot for US equity valuations, where the higher it climbs, the harder things will be down the track.

4. Global Monetary Policy Pivot: Traditional Policy Stimulus

The policy pivot of 2019 was a key theme for me, and was on a path to set the tone for 2020... of course then covid happened: thus came policy pivot part 2 (or perhaps: policy panic!). With the grand benefit of hindsight, the historic stimulus efforts (traditional + non-traditional, monetary + fiscal, coordinated across countries, and very rapid announcements + implementation), all basically worked. The economic life-support measures prevented things from spiraling down (we could have easily seen a credit crunch and default cascade), and indeed bolstered confidence and asset prices.

Naturally, if policy was helpful on the way up it stands to reason that it will be unhelpful when we get later into the cycle.

What to watch for: so the thing to watch for will be tightening of monetary policy - to me that is the biggest risk/catalyst to meaningful downside for equities. Valuations are one key part of the puzzle, policy is the other. Although we have seen things turn the corner on the global policy rate front, for now it is limited to smaller/developing/EM central banks who are more sensitive to the commodity/logistics-driven spike in inflationary pressures that are very clearly sweeping the world right now.

5. Global Policy Pivot: Extraordinary Policy Stimulus

Lastly, when I showed this chart this time last year I had drawn an arrow depicting where I thought the balance sheet expansion indicator would roughly go (i.e. up): it seems my imagination failed me there - the line surged to peak at roughly twice the level I had stylistically sketched. Clearly this was, and for now still is, a major tailwind for asset markets. Again: these things go in cycles, so we need to monitor the policy outlook and also decide what will drive policy decisions in the future.

What to watch for: again, if we believe policy was helpful on the way up, we have to believe it will be unhelpful on the way down - or i.e. at the end of the cycle. So really to justify moving structurally defensive in asset allocations we need to see alignment of expensive valuations and the removal of policy tailwinds (and more specifically, the introduction of policy headwinds). I think it's too early to talk about policy headwinds, but we are definitely turning the corner, and while some people may be lulled into thinking that policy stimulus is here forever, it is not: these things go in cycles.

Final Thoughts and Bottom Line

Bottom line: stay the course and watch the signposts.

While there are pockets of overvaluation, at the global level there are still meaningful relative value opportunities - and an absence of the types of widespread overvaluation seen at previous major tops in global equity bull markets.

At the same time, global equity market breadth has presented us with reliable medium-term bullish signals - and so far a lack of clear risk flags. Meanwhile, policy remains a tailwind for now, and until that changes, the big-picture medium-term view to me is one of "stay the course" in global equities.

At some point the time will come to turn structurally defensive in asset allocations, and for that we will need to pay close attention to the sign posts that I have outlined in this article.