On the surface, market commentators may easily come to the conclusion that there is a growing gap between the real economy and the stock markets.
The economic impact of the crisis is being felt more painfully day by day. Unemployment in the US is rising from 4% to 16% with more than 20 million jobs destroyed in April alone. IMF states that the global economic outlook has continued to worsen since mid-April and is now forecasting that developing nations financing needs probably will by far exceed the 2.5 trillion USD the IMF has projected previously.
Despite these news, financial markets have attempted an impressive recovery since the troughs in mid March. The S&P 500 is now back to levels of August last year, a time when restaurants and bars were still packed, lock-down and social distancing were unknown concepts and the sky was full of planes.
The main indices are however not at all representative of the real economy as shown with the 2 examples below:
1. The recovery in the S&P 500 has been driven by the usual tech suspects Alphabet, Amazon, Apple, Facebook and Microsoft who now represent 1/5th of the S&P 500. Beyond these tech darlings the situation in the US stock market is much more nuanced as shown by the below graph from Crescat Capital :
source: Bloomberg, Crescat Capital
The traditional value stocks have not recovered in the same way than the growth stocks and their underperformance has reached levels unseen since the bursting of the tech bubble. There may be good reasons for the underperformance of value like technological disruption and low interest rates. This gap however appears extreme to us: Ottavio Costa from Crescat speaks of a double top in value.
2. The US stock market is more the exception than the norm. Emerging markets and Europe now trade at much lower valuation levels in terms of cyclically adjusted PER and Price to Book. Unlike the US, they also trade at the valuations comparable to the ones seen during the financial crisis as can be seen from the below graph from StarCapital :
Source: StarCapital Research
To conclude, when looking below the surface stock prices of many businesses have painfully adjusted to the pandemic and reflect the current economic reality. This is especially true for value stocks and European / Emerging market equities. This is where the opportunities for the long term investors lie. We should not be completely blindfolded by the valuations of some US tech darlings, they may be good companies but could be priced for perfection.