US Equities: Conditions Are Not That Bad

Reading through the press of popular opinion this weekend one cannot help but feel that world stock markets are at a tipping point…….and that they are about to fall into the abyss! However, if we take an objective look beneath the scenes it would appear that world financial markets are less concerned about the US debt crisis than they were over the Greek debt "crisis" a few weeks ago.

It is said that a bull market creeps up on you when you least expect it. Well believe it or not the average stock in the world is about 3.2% below a level that would register a multi-week high. This isn't exactly the sort of behaviour you would expect given that the press of popular opinion are leading us to believe that a default by the US is immanent!

Below is my Proprietary World Index, actually there isn't anything special about this index. It is merely an equally weighted index of the top 5000 stocks in the world by market cap. It gives me an appreciation of the performance of the average listed stock in the world in common currency. The distinct lack of weakness is truly remarkable considering the level of fear that pervades in world financial markets right now.

See chart here

Now one of the primary reasons as to why I do not think that there will be any material downside in equity markets over the coming weeks is that equities have entered the "extreme cheap zone" relative to treasuries. Only three occasions in the last 30 years have equities been this cheap relative to treasuries! The chart below gives the differential between the earnings yield of the S&P 500 less that of the US 10yr treasury. The differential currently stands at 4.2% which clearly indicates that there is a massive risk premium being attached to the earnings of equities, that investors do not believe corporate profits are sustainable.

It is interesting to note that in the past whenever the earnings yield differential went above 4% it marked a long term cyclical low in the stock market.

See chart here

So while the press of popular opinion makes things look a little precarious right now, if you dig beneath the scenes conditions are not that bad, actually they are quite favourable. Global equity markets are only a few percent off multi-week highs yet sentiment is so toxic towards equities and corporate earnings that only on three occasions in the last 30 years have US equities been this cheap relative to treasuries. To quote John B. Templeton…….equity markets are born in pessimism, grow in scepticism, mature in optimism, and die in euphoria. I think that we remain in the pessimistic stage and that a dramatic bull market in equities still awaits us.


------

Get your market information daily from The Daily Trading Report. 3 Portfolio's trading concurrently you can view on demand helping you become an independant trader. Join our members community and discuss the markets with fellow traders from around the world. Get your trading tips, trading mentorship, trading reports from www.TheDailyTradingReport.com