Business

Stretched valuations for every major asset class

Last Monday's column discussed the US Federal Reserve Bank of Philadelphia's Partisan Conflict Index, which tracks the degree of political disagreement among US politicians at the federal level by measuring the frequency of newspaper articles reporting disagreement in a given month.

"Higher index values indicate greater conflict among political parties, Congress, and the president."

Given that this index is hovering around an all-time high and since the Dow Jones Index is also at record levels having crossed 22,000 last week, the conclusion is that the greater the political antagonism, the better it is for US stocks - and by extension, other equity markets.

Over the past week, President Donald Trump has fired his newly-appointed communications director.

Though that sacking is not indicative of partisan conflict, it goes towards demonstrating the chaos currently plaguing the US' corridors of political power.

Also in the past week, The Washington Post's Robert Samuelson suggested that Mr Trump may subconsciously be flirting with impeachment proceedings.

This, according to Mr Samuelson, would gel with Mr Trump's apparent need to be the centre of attention all the time, a need manifested in his constant tweeting of messages that often seem to be ill-conceived, sometimes misleading and regularly hastily constructed.

If Mr Samuelson is right ("Trump's dream: impeach me please!'', BT, Aug 4) then such proceedings, if and when they are launched, might represent the ultimate in political conflict. Going by recent market behaviour, it would mean yet more all-time highs for Wall Street.

It has to be pointed out though, that if the reasons why political conflict should be good for stocks are unclear, then what is clear is that there are fundamental reasons for being positive on equities, the main one being that economic growth seems to be firm, if somewhat moderate.

The advance estimate of second-quarter real GDP growth released by the US Bureau of Economic Analysis on July 28 was 2.6 per cent.

However, some observers quite rightly maintain that this is not robust enough to justify current valuations.

Natixis Global Asset Management's chief market strategist David Lafferty, for example, in his Capital Market Notes "The Big Short'' last week, said the entire outlook for risk-on assets is predicated on the continued and synchronised expansion of the global economy.

"In that sense, the current view of most investors with this mindset is one giant bet on the status quo... that is, one giant short on volatility!

"Without the strengthening fundamentals, what would we be left with? Extended valuations, rising geopolitical risks, and central banks that are withdrawing the punch bowl - albeit slowly''.

He also said that there are now "stretched valuations for virtually every major asset class as measured by yield levels for sovereign bonds, credit spreads for the corporate sectors, cap rates for real estate and most price metrics across equities...''

Quite logically, Mr Lafferty recommends investors partake of the economic recovery through risk assets but not stick their necks out too far as this is not warranted by valuations.

"At these prices, discretion remains the better part of valour'' was his conclusion, which is extremely sound advice, even as the US political machine grinds inexorably towards even greater conflict.

This article appears in The Business Times today. For full listings of SGX prices, go to http://btd.sg/BTmkts