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Are stocks too expensive?

Many investors are getting nervous about the stock market rally over the past few weeks.



The S&P500 index hit a 2012 high of 1,470 while the SET hit a 16-year high last week. Some investors are now wondering whether stocks are too expensive. To answer the question, I would point to a different direction - the bond markets.

In relative terms, bonds are much more expensive than stocks. As fear of the Euro break-up elevated in June, investors sold stocks and bought high-quality sovereign bonds such as those of the US and Germany to reduce their risk exposure. The price of US treasuries rallied 5 per cent in the second quarter, pushing the bond yield to a record low. Ten-year US treasury yield hit a 200-year low at 1.4 per cent and short-term German bunds are trading at flat or negative yields.

The 10-year Thai government bond yield also came down, from 3.8 per cent to 3.6 per cent. In other words, investment in bonds is yielding low returns with very limited potential gains. On the other hand, stocks are still trading at a discount. The MSCI Asia-Pacific ex Japan index is currently trading at 12 times P/E ratio, or 15-per-cent discount to its long term average P/E of 14 times.

Low bond yields also make stocks more attractive because of the yield gap. While bond yields have dropped towards zero, stock investors can still expect around 3 to 4 per cent from dividends. The difference between stocks' dividend yield and bond yield is at a record high level.

A recent survey of global fund managers shows that professional money managers are still keeping a lot of cash sitting on the market sidelines. The 173 institutional fund managers who took part in the monthly survey expressed greater optimism towards global economic recovery.

In our view, we expect that cash kept by fund managers and money invested in low-yielding government bonds will flow back into stock markets in the third quarter. We also recommend that investors switch equity holdings from the leading markets such as Thailand and the US (which have outperformed other markets this year) to lagging markets like Asia-Pacific ex Japan so as to capture more upside from this rally.

Komsorn Prakobphol is Wealth Manager at Tisco Asset Management.


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