Sunday, June 14, 2009


Does valuation not matter any more?
  • Asian markets are up 65% since early March
  • Valuations are becoming a concern, with prospective PE now 16.3x and PB 1.9x
  • For markets to rise much further requires a bubble
We wrote a month ago – in the AI of May 8 – that it was time for Asian equities to “take a breather”. Our main argument was that the better news on the economy was already largely priced in to markets. Markets did briefly pause for breath in mid-May, but in the past week or so they have set off at a sprint again. Since our piece, Asia ex Japan is up another 9% – taking the rebound since March 2 to 65% (Chart 1).

We are now starting to get alarmed about valuations. PE (based on 12-month forward earnings) for Asia ex Japan has reached 16.3x. Even if we use analysts’ forecasts for 2010 (which are highly optimistic, expecting 30% EPS growth (Chart 2), with many countries expecting a new peak for earnings), PE is still a pricey 14x. Price/book is similarly expensive at 1.9x. We think that comparisons with the normal (i.e. pre-bubble) phase of the last bull market, 2002-6, are most useful: in that period PE averaged 11.4x and PB 1.7x. And, even though the economy is clearly improving, we find that the market has already discounted the US manufacturing ISM getting back to 55-60 (it is now 42.8) by the autumn.

In this AI, we look at various possible reasons why multiples could justifiably be higher this time around – lower interest rates (maybe), less risk (hardly), higher expected trend growth (unlikely) – but reject all of them. The truth is that if Asian stocks rise much further they will, frankly, be getting into bubble territory. We think markets need to move sideways for a couple of quarters to allow fundamentals to catch up.

To see full report: ASIA INSIGHTS