Deutsche Bank: A 15%-35% "Hope" Premium Is Now Priced In
Confused by the recent surge of capital into Europe (which somehow is supposed to indicate that all is well because local stock and bond markets are faring better)? Don't be: it is merely the latest and greatest manifestation of that most prevalent of New Normal investment strategies: hope. Hope that this time it is different, and that the latest injection of capital from the Fed via QE3 coupled with the OMT perpetual backstop of liquidity via the ECB (still merely at the beta stage: expansion to actual gold/production phase TBD) will kick start the European economies. Alas, it won't, at least not until Europe actually undergoes the inevitable internal devaluation which we described over the weekend (since an external one is impossible) and crushes local wages of the PIIGS, which in turn would lead to revolution, and thus will never happen. That, or somehow discharges about 40% of consolidated Eurozone debt/GDP, which it also won't as it would wipe out the global banking system. So what does this mean? Well, as Deutsche Bank explains looking simply at manufacturing output in the developed world, global markets are now overvalued anywhere between 15% and 35%. This is the hope premium now embedded in stock prices.
From Deutsche Bank:
Our view over the last two or three months has been that the great central bank liquidity promises of August/September (QE infinity and the OMT) has probably bought markets up to 6 months of grace where hope for a recovery can be as or more important than the hard evidence. However our view is that if growth doesn't materialise by around Q2 of next year markets could sharply decline again. One simple way to frame this is to look at our often used relationship between PMIs/ISM and the YoY change in equities in each country. At current PMI/ISM levels, US, Italian, German and French equity markets range between 15% and 35% overvalued using this very simplistic model. Put the other way round we are pricing in PMIs/ISM around the mid-50s level instead of the 49.5 (US), Italy (45.1), 46.8 (Germany) and 44.5 (France) we saw yesterday. Interestingly Spain's equity market is only 4% away from the -10% YoY that it's 45.3 PMI suggests it should be.
Overall as we always say these numbers should be treated with great caution but they are a useful broad guide as to whether markets are behind or ahead of the data. At the moment they are way ahead and despite the simplistic nature of this relationship we're confident with the conclusion that if PMIs aren't comfortably above 50 as Q2 2013 progresses, markets will be notably lower than current levels. Given that most economists expect the recovery to be building by Q2 then maybe markets are right but it shows that there's not much room for error on this.
In other words: all those bullish sell side research reports saying the world may get better in 2013, if it doesn't get worse: they are all now priced in, and then some. If they don't materialize, the downside is now knows.
In other words: all those bullish sell side research reports saying the world may get better in 2013, if it doesn't get worse: they are all now priced in, and then some. If they don't materialize, the downside is now clear.
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