Head of Equity Strategy
Summary: Equity valuations have hit highest levels since the 1960s which in itself is scary. On a forward basis, equity valuations are also suggesting investors are willing to pay high prices for equities. But everything should be viewed in relative terms and with US 10-year yield at historically low levels the current equity valuations do not look as stretched as one would think. We also take a look at the surging container rates and food prices indicating inflationary pressures. Finally, we comment on yesterday's Snowflake earnings dividing Wall Street analysts.
Global equities had its best month November going back many decades. Surging equities and the implosion in earnings in the first half of the year has pushed the 12-month trailing EV/EBITDA ratio to the highest level measured since this ratio was available for the MSCI World Index in January 1995. We know equity valuations were low during the high inflation years of the 1970s and 1980s and that the dot-com bubble in 2000 marked the high on equity valuation. As a result, we think it is fair to say equities are the most expensive since the go-go years of the 1960s bull market.
While the trailing valuation ratios show a disturbing level, they do not represent what is relevant for equities. The 12-month forward EV/EBITDA ratio reflect the expected rebound in corporate profitability in 2021, but even on this measure the global equity is beginning to look stretched with highest valuation level since 2005 when forward looking measure on MSCI World is available. Should you be worried as an investor and sell your entire equity portfolio?
Valuations reflect investors willingness to pay for income streams. One of the key input variables is the discount rate which is essentially the risk-free rate plus a premium that considers associated risks related to equities. The US 10-year yield is still below 1% which is significantly below the 6-7% in the years 1995-96. When we compare current equity valuations to the dot-com years we must consider the alternative risk-free option. Back in 2000, an investor could lock in around 6% risk-free yield over ten years against buying equities at the highest level since the 1960s. The risk-reward ratio was bad for equities. Today, an investor pays 13x next year’s EBITDA which is roughly an operating income yield of 7.7%. If we use the free cash flow yield it is currently 5.9% on the MSCI World Index. Compared against 1% in the US 10-year yield the risk-reward ratio still looks attractive despite high equity valuations. When government bond yields are historically low we should also expect equity valuations to be historically high.
On our daily morning podcast, we have been highlighting the rapidly rising global container benchmark rates. Our Head of Commodity Strategy, Ole S. Hansen, has created the charts below of the four main container benchmark rates and they all show significant levels compared to the 5-year average range. Especially European container rates have accelerated a lot the past couple of months reflecting the strong retail sales figures. While logistics costs are only around 10% of overall costs these significantly higher shipping rates do contribute to inflationary pressures. The UN FAO Food Index is also out today showing more pressure in November which we analyse in today’s Food inflation ran wild in November.
Snowflake Q3 earnings have Wall Street analysts divided
One of the hottest IPOs this year was the Snowflake IPO which wrote about in September in our analysis Snowflake enters equity market with red hot valuation. Last night the company released its first earnings release and numbers were strong. Q3 revenue was $159.6mn vs est. $147.1mn and guided FY21 (ending in January 2021) product revenue of $538-543mn and Q4 revenue of $162-167mn which disappointed analysts and investors as it only translate into q/q product revenue growth of around 11%. We are guessing that the market is surprised about this number as it suggests a faster growth decay than were most analysts had expected. Most analysts have Snowflake shares at hold with a consensus price target of $293. On the positive note, customer commitments continued to rise rapidly in Q3 FY21 suggesting high revenue growth in the future is intact.
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