Global share markets have been running hard and in synch this quarter and especially this month as we show below. There is a natural inclination to think that this is all too much too soon and a lightening of equity exposures is called for. The lead steer of the global herd is clearly the S&P 500. Where New York goes other markets follow. However the S&P 500 is much more than a play on the US economy – about 40% of S&P 500 revenues and earnings come form outside the US (just as the JSE ALSI is much more than play on the SA economy). Stock markets list global companies whose fortunes and valuations depend upon the global economy.
The JSE EM and S&P 500 1 July 2009=100
Source: I-Net Bridge and Investec Private Securities
Fundamental analysis of the relationship between dividend yields on the S&P 500 and US Treasury bond yields indicates that the S&P 500 is far from being exuberantly valued. The indication is that the market has moved higher from a position of extreme undervaluation of dividends relative to long term interest rates to less undervalued, but still significantly undervalued.
In the figure below we show the output of a regression equation that explains the level of the S&P 500 with dividends declared (a positive influence on valuations and US T bond yields, though a negative influence normally). The current dividend yield on the S&P 500 is a respectable 2.2% and the 10 year bond yield a low 3.398%.
As may be seen in the difference between the lower actual value of the S&P 500 and its higher value predicted by the model, is still of the order of 30% having been as much as 83% earlier in the year.
Under or overvaluation is indicated in percentage terms in the residual – that is the difference between actual and predicted values in log terms. The value of the S&P 500 Index as predicted by the model is as heady a number of 1435 as we show in a further figure. The model should be treated as no more than an indication of fundamental value – provided dividends are maintained and interest rates do not shoot higher – the New York market does appear to still offer value.
The dividend discount model of the S&P 500
Source: I-Net Bridge and Investec Private Securities
The actual and predicted by dividend discount model of the S&P 500
Source: I-Net Bridge and Investec Private Securities
When a similar modelling technique is applied to the JSE FINDI, the FINDI is explained by the level of the Emerging Market (EM) Index. FINDI reported earnings and short term interest rates in SA show that the FINDI appears fully valued. Or in other words the FINDI, as is readily apparent, has kept pace with its global peers. Further strength in the FINDI therefore depends on further advances in the S&P 500, which the EMs are bound to follow. The chances of further advances in the S&P 500 should not be discounted, as we have suggested.
The model of the JSE Findi – full valuation indicated
Source: I-Net Bridge and Investec Private Securities
Actual Vs Predicted value of the JSE FINDI
Source: I-Net Bridge and Investec Private Securities