The market crash has caught many investors off guard. However, a steep decline in equity prices might also be seen as an investment opportunity, especially given how elevated valuations were over the past few years. In this analysis we evaluate how specific equity indices look compared to each other and also investigate how the past bear markets in the US played out.
Which markets do offer a better value?
Coronavirus pandemic caused massive declines on global stock markets. Some were hit harder than others but no one was spared. However, as the situation calmed, people started to wonder which markets could be winners once recovery starts. Investors often try to single out stocks that could outperform during the crisis or in the initial recovery phase but just as well this logic could be applied to the whole markets (indices).
The approach we took was to look at the current valuation metric - price to earnings and price to sales, and compare it with a 10-year average. Obviously corporate results will deteriorate substantially over the next year so investors should expect a significant discount from the average. This is one thing and we present it on the horizontal axis of the 2 charts below. Then again not all apples are the same. Some markets might have persistently higher p/e or p/s ratios having more growth oriented stocks and markets where companies were able to improve results may also offer a smaller discount compared to those where the results were stagnant (or even declined). This is the vertical axis.
MEXComp, RUS50 and W20 look attractive judging by the price-to-earnings discount and their growth in the past. Among the developed markets NED25 and FRA40 look relatively good. Source: Bloomberg, XTB Research
On the chart above we have provided data for some major equity indices. 5-year earnings growth rates were plotted with current deviations from 10-year average P/E. The general idea is that indices which lie above the blue line are more attractively valued. Why is that? Because they trade at a bigger discount to its historical earnings multiple and have higher earnings growth rates. Here you can see that after the end-of-quarter rebound some markets do not even offer a discount anymore! This is especially true for the Korean KOSP200 but also tech-heavy US100 and investors’ favourite: DE30. On the other end of the spectrum you can see mostly emerging markets: MEXComp (Mexico), RUS50 (Russia), and W20 (Poland). Be careful with RUS50 as a major discount could not even reflect a steep fall of oil prices. From the developed markets sphere NED25 and FRA40 seem to be offering better value using this method.
Similar chart with price-to-sales data and sales growth rate also highlights the relative attractiveness of RUS50. Source: Bloomberg, XTB Research
A chart with historical P/S values and sales growth rates plotted against each other looks similar. However, as one can see indices are less dispersed. Most of the European indices lie close to the blue line but FTSE 100 (UK100) looks to be in slightly better position than the rest. As one can see, Dow Jones (US30) looks to be the most attractive among US indices. Russian RTS index (RUS50) looks attractive on both charts but as we pointed out - this is oil related. Chinese stocks seem to be by far the least attractive judging by both metrics.
Timing could be the key - can we learn from the past?
Comparison of different bear market periods (100 = pre-crash peak). Source: Macrobond, XTB Research
After a stock market crash everyone asks themselves - is it a good time to buy equities already? The question is especially tricky to answer now as we are facing a crisis of an unprecedented scale. However, we can use historical performance of stock markets during crisis times as a guide. As one can see on the chart above, the ongoing market sell-off is looking very similar to the stock market crash from 1987. However, the economic situation could not be more different than between those two events. Nevertheless, levels that marked 35, 45 or 55% drops from the pre-crisis peak often served as turning points during other sell-offs. As no one knows how deep the market will fall, a wise approach may be to divide capital and entry levels rather trying to find the very bottom and either enter too early with the whole capital or miss out on the opportunity altogether.
It’s good to have a plan
Summing up, RUS50 looks promising both in terms of earnings and sales but other emerging markets and some developed ones also are more attractive than a standard and do not have a burden of low oil prices. Levels like -35%, -45% or -55% off the peak served as turning points in the past and while every bear market is different this experience could help navigate the timing. However, as a word of caution it should be said that we are less than 50 days past the peak and during some sell-offs, like for example 2000-2002, the market did not bottom until a year and a half after the peak. This might suggest that the move lower could be often intercepted with mini rallies like the one we saw towards the end of March.
US500 jumped around 20% off the bottom reached on March 23. However, the index got locked in the consolidation ranging between 23.6% and 38.2% retracement levels (2,470-2,635 pts range). With quarter-end rebalancing out of the way, the index may now more closely reflect economic reality. Should things turn ugly, support at 2,400 pts is the next one to watch. Source: xStation5
