The synchronization of stock valuation and (inverse) real returns has seldom been as high as in the past five years. That doesn’t bode well for 2021.
After the devastating slump in the spring, risky assets have performed as strongly as probably no one would have expected them to in March. After a strong upward movement in the summer months, there was a breather in September and October before the rally resumed its course in November. With an increase of 11.9 percent, November 2020 ranks number two of the strongest equity months since 1970, measured by the MSCI World Index. Only in January 1975 was there an even greater increase. (1)
On the one hand, the markets draw strength from the economic recovery, which suggests a significant increase in corporate profits for 2021. However, it was not just profits that made prices rise, but valuations too. One could object that at the beginning of a cycle the prospect of increasing profitability is regularly anticipated by higher valuation multiples, above all the P / E ratio (price-earnings ratio). But even if you take the expected 2021 profits as a yardstick, the valuations are well above the historical average. One reason for this is likely to be found in the bond market, as can be seen from our “Chart of the Week”. For several years now, an interesting, inverse correlation has been observed between stock market valuation and the development of real government bond yields (2).