Equities in the U.S. and Europe are too expensive compared to their value, says Russell Investments in its second quarter economic update.
Equity valuations in developed markets appear stretched relative to the end of 2013. With a price-to-book floating near 2.7x and a cyclically adjusted price-to-earnings ratio over 20x, the U.S. equity market, as measured is valued at levels not seen since late 2007, which the team Russell Investment’s analysts say are expensive. The strategists expect the economy to continue recovering from the tough winter and follow predictions for moderate, low-inflation growth.
Eurozone equities are also slightly expensive, the strategists note, while Japan’s price-to-earnings ratio of 13x and price-to-book of 1.3x, indicate valuations that are more fair. There’s a positive business cycle outlook for Japan, as earnings-per-share are being revised higher and additional fiscal stimulus is underway. Still, Japan may have lower growth this year than in 2013 as a result of this spring’s consumption tax rise.
Expect producer and consumer confidence to drive Europe’s moderate economic recovery to continue. However, the strategists say recent inaction by the European Central Bank may have let deflationary forces to take hold, leading to heightened downside economic risk.
As for emerging markets, the business cycle there continues to face challenges as a result of China’s tighter credit conditions and slowing commodity demand, and more generally from rising inflation and the after effects of currency devaluations. But the markets are currently a bargain, with about a 30% to 40% undervaluation relative to developed markets. Investing there is still a risk, as the team finds that emerging markets generally have a negative sentiment with negative momentum and no indicators signaling a shift in momentum.
The U.S. market leads other developed markets globally in terms of sentiment as strong forecasts for economic data in 2014 balance out the Fed’s plans to continue a moderately paced tapering of its asset purchasing program. Japan comes next, having recently reached new highs in a wide range of economic indicators, including base money growth, CPI inflation, employment growth, and corporate profit margins. Eurozone sentiment also has improved due to capital inflows and outperforming risk assets.