Iseq remains in bargain basement

STOCKTAKE: A VALUABLE long-term valuation metric suggests the Irish stock market is one of the cheapest in the world.

US investment manager Mebane Faber calculated cyclically-adjusted price-earnings (Cape) ratios for 32 different countries. Cape averages earnings over 10 years, ironing out business-cycle volatility.

“We found most Capes averaged around 15-20, bottomed out around 7, and maxed out around 45,” says Faber. The Irish ratio is now just 7, with only Greece (3.26) and Italy (6.96) cheaper.

On only nine occasions have individual Cape ratios dipped below 5, with Ireland in 2008 being one of them. Such instances occur in moments of “total crisis”, but investors who take the plunge are usually very well-rewarded.

The Iseq has risen by one-third since last October, but Cape suggests it remains in bargain-basement territory.

US markets not so bullish without Fed

US MARKETS sold off last week after they didn’t get their “shot of Red Bull” from the US Fed, said strategist Barry Ritholtz.

Market dependence on Fed liquidity goes back to 1987. A new study by two New York Fed economists reveals the extent of this dependence – since 1994, 80 per cent of US equities’ excess returns have occurred in the 24 hours leading up to Federal Open Market Committee (FOMC) announcements. The two days after the announcement are also bullish – excluding these three-day periods, US equities have been essentially flat since 1994.

The FTSE, German Dax, French CAC 40, Canadian TSX and other major indices do not behave similarly in advance of their central bank announcements, although they do display the same "pre-FOMC announcement drift". The study is at iti.ms/Sih1k9.

Obama’s odds track market movement

STOCKS are fighting many headwinds at the moment, but bulls are hopeful the upcoming US presidential election will help juice returns. Since 1964, the SP 500 has averaged gains of 9.7 per cent between June and September on the eight occasions an incumbent has run for re-election, blogger Eddy Elfenbein has noted.

Price gains during these months usually lead to re-election, while market losses indicate incumbent defeats. Since 1948, this indicator has worked on all but one occasion. That’s why Mr Obama’s re-election odds have closely tracked stock movements over the last 18 months.

Like the FOMC indicator, this US phenomenon has global implications. The US election cycle explains a “sizeable fraction” of equity returns in developed and emerging markets, Goldman Sachs noted last February.

Early earnings fall short of forecasts

US EARNINGS season began on a sour note last week. Just one of the first 16 companies to report beat expectations, said Bespoke Investment Group, with 12 missing estimates.

Analysts expect a decline in second-quarter earnings, and have been lowering estimates since last summer. However, Bank of America strategists warned last week that estimates remain optimistic, and are “in the early stages of being reset lower”.

Still, expect most companies to beat estimates. The numbers have always been gamed – on average, 62 per cent of companies beat estimates. In fact, at least half of US firms have beaten forecasts for 56 consecutive quarters.

Euro to trend lower

THE EURO, which traded at $1.34 against the dollar in February, last week fell to $1.21. That brought it below the OECD’s measure of purchasing power parity for the first time since June 2010, notes currency strategist Marc Chandler.

Today’s 2.3 per cent under-valuation is a “minor overshoot”, however – the euro was 23 per cent over-valued in 2008, and 35 per cent undervalued a decade ago. Forget mean reversion strategies, says Chandler, and “look for the euro to continue to trend lower”.