Many unreliable Valuation measures are still being used by analysts, says Pimco's Bill Gross
Many of the suspect valuation measures propagated at the height of the bull market continue to be used to paint an unrealistically bullish picture for 2003, Bill Gross, managing director of Pimco, has claimed.
Gross, the leading investor at Dresdner RCM's sister group and manager of the Dresdner retail bond funds, said: 'Despite the introduction of a new, commonsensical earnings measure by Standard & Poor's, called Core Earnings, many analysts go their own way in promoting permutations.
'Nearly unanimous commentary focuses on how the S&P 500 companies will earn more than $50 per share in 2003. That number makes current market levels of 900 seem reasonable because of the 18 times P/E ratio $50 implies.'
But that story belies the underlying unpalatable truth for equity managers, according to Gross. 'You have to dig real hard to learn that these expected earnings are what are called 'proforma' earnings,' he said.
According to S&P's core earnings measure, Gross added, the nearly $42 per share of operating earnings S&P companies reported as of June this year should have read only $18.48.
Gross said: 'Being bearish on stocks, I use the $18.48 to present a shocking alternative. Bulls grab for the $42 and $50-plus next year because it makes their holdings seem rational. Surely the reality lies somewhere in between? The rub of course is which number comes closest.'
Gross moved to reassure investors there is little reason to fear a bond bubble had formed, driven by investors' extreme caution on equities.
'I am somewhat incredulous at recent commentary suggesting the bond market is mimicking the same bubble produced by stocks several years ago,' Gross said. 'These warnings, of course, are generally self-serving, meant to wean money back into the stock market, which generates the most commission and the highest fees.'
Given a near deflationary global economy, while US Treasury yields are fully valued, they are also near fairly valued,' Gross believes. While he admits it is unlikely Fed funds will stay around 1% for long, he noted inflation is expected to remain subdued for some time yet, thereby supporting 10-year Treasury yields at near 4% levels.
'Stocks with suspect proforma earnings remain the bubblish investment to me. And while Greenspan's Fed model may show stocks undervalued against 10-year Treasuries, when using Baa corporate yields, they are by even conservative measures nearly 30% overvalued.'
Neil Birrell, chief investment officer at Framlington, agrees the bullish outlook for global equities in 2003 appears uncertain.
With traditional distinctions between growth and value stocks becoming blurred, Birrell said, the key issue for investors is not growth or value but the riskiness of future profit streams.
The valuations companies can achieve are the key driver, he added.
Framlington is currently overweight the UK as it believes UK equities continue to offer the best value on a global basis. Jonathan Asante, chief economist at the group, said the background to the UK economy looks solid following Government commitments to spending. Framlington favours companies that will see the benefit from this, such as building and construction firms.
The US is another overweight position for the group. However, Asante said low inflation and consumption growth means the recent improvement in profitability in US companies is unlikely to be strong.
'Asian manufacturers are undermining the pricing power of American companies, further reducing the revenue outlook,' he said.
'Some US companies could even be pushed out of certain industries entirely, such as car production, in the next few years.'
A key issue in Europe, where Framlington is underweight, remains the performance of the German economy, said Asante. However, the group believes Germany will deliver much better policy responses to resolve the issue than Japan.
If European markets continue to underperform, he added, the region will become attractive on valuation terms.
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