The Global Stock Market Decompression
In the most recent quarter, global stock markets continued to reverse the valuation compression which occurred in the first quarter.
In the first quarter of the year, during the worst of the COVID crisis, global markets collapsed in value. What that means is that prices of stock indexes went down faster than earnings. The most common way to measure valuation is called a P/E Ratio. It’s the price of the stock (or of a collection of stocks, such as all the stocks in a country’s market), divided by the last 12 months of earnings. When prices are dropping faster than earnings, that’s called valuation “compression.” When prices rise faster than earnings, that’s called valuation “expansion.” Compression and expansion are changes in the price that are not driven by changes in the earnings of the market. A valuation approach sees this compression, this lowering of valuation, as attractive. It’s as though earnings are “on sale” compared to times when valuation has expanded and prices are high relative to earnings.
Last year was the story of very rapid compression in the first quarter, and very rapid expansion in the last quarter. Picture global stocks as a gigantic rubber ball. Market panic squeezed the ball in the beginning of the year and then by the end, as the panic wore off, the ball was able to expand back to normal.
Let’s look at the data. Below you see two maps. On the left is the performance of all the stock markets in the world which we track in our universe. The color coding is: Red = negative return; yellow = zero or near zero return; green = positive return. The various hues of red and green show the varying relative size of the losses or gains.
What you can see is that it was a good quarter for global stocks. They all gave a positive return.
The map on the right shows the change in valuation, that is, the change in the price relative to the earnings. Red/orange = less attractive valued (expansion); green = more attractively valued (compression).
It was generally an expansionary quarter. Of the 42 countries shown here, only five got more “on sale”. The rest got more “marked up.”
The scatter chart below the two maps shows the story a slightly different way. It compares each country’s return (the up and down axis) to that same country’s change in valuation (the left to right axis). Moving right is more attractive. That line is called a “regression line,” it shows the relationship between the two factors. This one tilts downward, which means they negatively correlate.
So, the general story is that the countries which performed best in returns tended to do so by becoming less attractively valued and vice versa, which was the opposite of the general pattern in the first quarter of the year. Over time, valuations tend to gravitate back towards normal and this year was not an exception: The panic compression in the beginning of the year, reversed by expansion at the end of the year.
Originally published on Townhall Finance.
Jerry Bowyer is a Forbes contributor, contributing editor of AffluentInvestor.com, and Senior Fellow in Business Economics at The Center for Cultural Leadership.
Jerry has compiled an impressive record as a leading thinker in finance and economics. He worked as an auditor and a tax consultant with Arthur Anderson, as Vice President of the Beechwood Company which is the family office associated with Federated Investors, and has consulted in various privatization efforts for Allegheny County, Pennsylvania. He founded the influential economic think tank, the Allegheny Institute, and has lectured extensively at universities, businesses and civic groups.
Jerry has been a member of three investment committees, among which is Benchmark Financial, Pittsburgh’s largest financial services firm. Jerry had been a regular commentator on Fox Business News and Fox News. He was formerly a CNBC Contributor, has guest-hosted “The Kudlow Report”, and has written for CNBC.com, National Review Online, and The Wall Street Journal, as well as many other publications. He is the author of The Bush Boom and more recently The Free Market Capitalist’s Survival Guide, published by HarperCollins. Jerry is the President of Bowyer Research.
Jerry consulted extensively with the Bush White House on matters pertaining to the recent economic crisis. He has been quoted in the New York Times, The Wall Street Journal, Forbes Magazine, The International Herald Tribune and various local newspapers. He has been a contributing editor of National Review Online, The New York Sun and Townhall Magazine. Jerry has hosted daily radio and TV programs and was one of the founding members of WQED’s On-Q Friday Roundtable. He has guest-hosted the Bill Bennett radio program as well as radio programs in Chicago, Dallas and Los Angeles.
Jerry is the former host of WorldView, a nationally syndicated Sunday-morning political talk show created on the model of Meet The Press. On WorldView, Jerry interviewed distinguished guests including the Vice President, Treasury Secretary, HUD Secretary, former Secretary of Sate Condoleezza Rice, former Presidential Advisor Carl Rove, former Attorney General Edwin Meese and publisher Steve Forbes.
Jerry has taught social ethics at Ottawa Theological Hall, public policy at Saint Vincent’s College, and guest lectured at Carnegie Mellon’s graduate Heinz School of Public Policy. In 1997 Jerry gave the commencement address at his alma mater, Robert Morris University. He was the youngest speaker in the history of the school, and the school received more requests for transcripts of Jerry’s speech than at any other time in its 120-year history.
Jerry lives in Pennsylvania with his wife, Susan, and the youngest three of their seven children.
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