A blistering start to the year for stock markets around the world has pushed many to record highs and stoked fears of a bubble of historic proportions.
However, investors should not look at the stock market in a vacuum and instead must compare it with alternative places to put their money. With bond yields at near-record lows, this increases the appeal of stocks, which offer better return prospects.
We look at three charts which show stocks are not in a bubble.
Bond yields do not beat inflation
Yields on $18trn (£13trn) of bonds are now negative, according to Pictet, the asset manager. “It’s going to be a tough environment for bond investors, particularly with inflation likely to rise,” said the firm.
Two-year British government bonds, known as gilts, have a negative yield, at -0.12pc. Gilts with longer to maturity offer higher yields as they carry more risk that inflation will rise and destroy their value. But even 10-year gilts only marginally beat inflation, yielding 0.31pc, just above the consumer price index’s 12-month rate of 0.3pc, while 30-year bonds yield only 0.91pc.
American government bonds tell a similar story, with 10-year Treasury bonds yielding 1.15pc, below the country’s 1.4pc inflation.
Yields this low mean that bonds are not appealing when compared with stocks. So while stocks are expensive, it is still worth owning them.
Laith Khalaf, of fund shop AJ Bell, said bonds were unbelievably expensive which made stocks relatively more attractive.
“Investors need somewhere to go and it makes sense that they are still buying stocks,” he said.
However, he warned that if interest rates rose, or investors expected them to, bond yields, which move in the opposite direction to prices, would also rise and stocks would become less attractive.
“Interest rates probably won’t rise this year but if we see an economic recovery then they could,” he said.
Stocks are cheap versus bonds
Another way of assessing the effect of low bond yields on stocks is to look at the excess Cape yield, an indicator created by Nobel prize-winning economist Professor Robert Shiller.
It measures how expensive stocks are when the yields on bonds are taken into account. Prof Shiller found high scores – which mean stocks are better value – across all regions, and all-time highs in both Britain and Japan.
“This indicates that, worldwide, stocks are highly attractive relative to bonds right now,” he said.
In America, as shown below, the score stands at around 4pc, which is much higher than in the 2000 dotcom boom when it turned negative.
Not all tech firms are expensive
When investors assess how expensive shares are, they often focus on companies like Amazon, Netflix and Tesla which have eye-watering price-to-earnings (p/e) ratios, which measure how much shares cost versus their profits.
However, Mr Khalaf said some of the biggest technology companies were actually trading at reasonable valuations considering their large cash piles and high growth.
While shares in Amazon and Tesla trade on p/e ratios of 90 and 800, Google-owner Alphabet, Microsoft, Apple and Facebook are far cheaper.
Mr Khalaf said: “While there are signs of extreme frothiness in the Tesla share price, not all technology stocks are ludicrously expensive. Apple, Alphabet, Facebook and Microsoft all have p/e ratios in the thirties, and while that’s by no means cheap, it simply reflects the high earnings growth these companies are able to produce.
“These aren’t like the flimsy companies which collapsed in the dotcom crash, these are robust, industrial titans which are indelibly plugged into daily life. That’s not to say they aren’t susceptible to a correction, but their valuations don’t deserve the bubble tag.”
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