Despite the claims by many market analysts, global equities are not cheap because earnings forecasts are much too high.
This was the unsettling message from hedge fund manager Dr Jamil Baz to delegates at the van Eyk annual conference in Sydney earlier this week.
“Profits are heading only one way and that is south,” said Baz, chief investment strategist at GLG Partners, one of the world’s largest hedge funds.
He argued that the painful process of deleveraging that economies would have to go through had barely started, particularly in Europe, noting the total debt to GDP ratio in Europe had not changed since the onset of the global financial crisis.
Governments also have few of the traditional weapons to offset the effects of debt reduction, such as lower interest rates, because these were already at near zero or zero.
“The crisis hasn’t even started and will take 15 years to resolve,” he said.
He noted that the sick economies of Europe would have to cut their wages by 25 per cent just to be competitive with Germany, something their populations would not tolerate.
“Even Mussolini couldn’t force such a wage decline in Italy,” he said.
The fact that European governments and Brussels were trying to impose this level of austerity on their populations showed the biggest deficit in Europe was a “deficit of democracy”.
Baz added that earnings forecasts for equities “were less about economics and more about theology” these days.
In his view, dividends are a better way of measuring valuations and on that basis equities are not cheap.
Corporate bonds were better value; even US Treasury Bonds were cheaper. He said the global equity risk premium over bonds was only 2.5 per cent when 5 per cent was more realistic given the economic situation.
However, there were some beaten-down equity markets he advised investors should be overweight in, such as Russia, the Middle East and countries in peripheral Europe.
Also addressing delegates was van Eyk’s head of research John O’Brien who warned investors to be cautious of possible black holes in the world’s financial system.
“Like the universe, there are at least three black holes in the world’s financial system whose nature and impact is not fully understood and have the potential to severely affect financial markets,” he said.
O’Brien nominated these black holes as computer-based high speed trading, inter-bank asset pledges and unfathomable valuations on developed market and emerging market banks.
