Continued upward path surprises

The global stock market rally from the March 9 lows began to run out of steam in October. This prompted non-believers of a potential V-shaped recovery to say the rally had gone too far and was due for a pull-back. However, markets have surprised again by continuing their upward path, says Plexus Asset Management.

Both the MSCI World Index and the MSCI Emerging Markets Index were back above their mid-October 2009 highs on 16 November, says Dr Prieur Du Plessis, Plexus group chairman. The MSCI World Index slipped below its mid-October high marginally on Tuesday, but the MSCI Emerging Markets Index is still above its mid-October high.
“This makes one wonder whether stock markets are overvalued and long overdue for a serious pull-back, or if they are priced fairly and reflect a better-than-expected picture for the global economy,” says Du Plessis.

According to Du Plessis, the 12-month momentum of the US equity market, as measured by the S&P 500 Index, narrowly tracks the US GDP-weighted Purchasing Managers Index (PMI). “Current levels of the S&P 500 Index indicate the market is expecting a GDP-weighted PMI in the region of 55 to 60,” says Du Plessis. “Given its current level, a rise to 55 in November is not impossible but unlikely. It can thus be deduced that the US equity market is overpriced by approximately 5% to 10% unless the fundamentals as measured by the GDP-weighted PMI stack up.” 

“With the GDP-weighted PMI leading corporate earnings growth, as measured by the S&P 500 Earnings Index, by six months, full-year earnings on the S&P 500 Index in the final quarter of this year are likely to be down by around 40% on last year. Twelve-month earnings momentum can be expected to improve to close to zero by the second quarter next year,” says Du Plessis.

“According to our research, the US equity market is anticipating positive earnings growth in the second quarter of next year. There is thus a significant risk that the market may be extremely disappointed with earnings growth,” he says.

“From an economic point of view, US companies in the transport sector should be closely linked to the manufacturing sector, as input goods and goods produced must be transported. The US manufacturing PMI is thus an excellent indicator of movements in equity prices in the transport sector. Given the historical relationship, it can be deduced that the Dow Jones Transport Index is correctly priced at the current level of the manufacturing PMI,” says Du Plessis.

He also believes sustained improvements in MZM (money supply with a zero maturity) velocity are likely to underscore the positive momentum in equity prices as the current situation is not dissimilar to major turning points in the past.

The Eurozone GDP-weighted PMI is an excellent gauge of the valuation of the European equity market. “The 12-month momentum of the German Dax Index as proxy for European equities currently indicates the equity market is discounting a rise in the GDP-weighted PMI to 55 in November. This is attainable and the German equity market can thus be considered as fairly priced given the underlying economic situation in the Eurozone,” he says.

The Japanese equity market is more complex to evaluate as factors other than the underlying economy play a major role. “Despite the relatively weak relationship with Japan’s manufacturing PMI, the current 12-month momentum of the Japanese equity market, as measured by the Nikkei 225 Index, points to a reasonably priced equity market given the current PMI.”

“Emerging-market equity prices, as measured by the MSCI Emerging Markets Free Index, are primarily driven by commodity prices and, in particular, by metal prices as measured by the Economist Metals Price Index,” says Du Plessis. “Currently emerging market equities are fairly priced given the level of metal prices.”
He believes the outlook for emerging-market equities remains positive given the positive outlook for metal prices on the back of improved global industrial production and stronger economic growth in especially developed economies.

“The ratio of the MSCI Emerging Market Free Index and MSCI World Index is also driven by commodity prices and specifically metal prices,” says Du Plessis. “The relative risk of investing in emerging-market equities has increased as the ratio has outrun metal prices. At best the MSCI Emerging Market Index could maintain the current relative levels against the MSCI World Index should metal prices move sideways. Metal prices need to rise substantially to ensure further outperformance by the MSCI Emerging Markets Free Index,” he adds.

Du Plessis’s advice to long-term investors who are underweight equities is to add to equity positions on any pull-backs. “Don’t necessarily bank on a big pull-back before doing anything,” he says. “There is still a lot of cash on the sidelines and, with the money market and bonds not offering good return potential, there are no real viable alternatives to the equity market over the next few years.”

This article was supplied by the Plexus group.
Dr Prieur du Plessis, group executive chairman can be contacted at 021 970 2400 or :   This e-mail address is being protected from spambots. You need JavaScript enabled to view it