The second half of 2005 will show a sharp deceleration in European and American activity. The world growth rate will decline from 4% this year to 3.7% in 2006, which is below its long-term average. This prospect will eventually weigh on stock markets, despite further weakness in long-tem interest rates.
European equities are cheap, however you look at it! Dividend yields (a measurement of income) on European equities are now lower than bond yields. If we take the DJ Stoxx 50 (a proxy for large European equities), for example, we note a dividend yield of 3.5%, compared with an average 10-year euro zone bond yield of 3.2%. In the UK, the dividend is 3.4% which is now only 80 basis points away from the 10-year bond yield. Historically the spread over the last 10 years has been about 2 points.
Bond market valuations are a good indicator to buy or sell equities. Currently the amount that is paid for a unit of earnings (PER) is 12.9x times which is well below its bond market equivalent 30x (the inverse of the bond yield). Ironically this phenomenon has persisted now for the past three years, a period too long for comfort.
Record profitability in Europe including the UK. European firms’ net margins are at record highs. At 5.5% in 2002, DJ Stoxx 600 margins are up to an estimated 8.5% this year, and are rapidly closing on US levels. Despite the damage caused by currency overvaluation and soaring prices of raw materials and oil, European firms have proved resilient. We remain convinced that European equities will perform relatively well, at least in the near term. The second half of 2005 is likely to be more difficult than the first. In the UK we expect a similar scenario. Although EPS growth rates have nicely increased from 9.2% to 11.2% in 2005, retail spending and other leading indicators are beginning to show cracks. Expect a harder fall.
|
|
% Change YTD |
EPS % Change 05 |
Forward 13M P/E |
Forward 12M Net Div Yield |
|
FTSE 100 Bench (GB) |
6.2% |
10.8% |
12.7 x |
3.61% |
|
FTSE All Share Ex Invt Bench (GB) |
6.2% |
10.9% |
12.8 x |
3.53% |
|
DJ Stoxx 600 Bench |
10.8% |
14.9% |
12.9 x |
3.28% |
|
S&P 500 Bench (US) |
-0.9% |
12.5% |
15.4 x |
1.88% |
FactSet Estimates June 23, 2005 in local currency
These views are independent of FactSet Ltd and are proprietary to Bobby Rakhit. For the full report and individual sector reviews and recommendations please contact rakhitreport@yahoo.co.uk