Global stock discounts vs US stock discounts

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Good morning. In a move that could have been designed to reignite fears about AI and employment, the payments processing company Block announced yesterday that it was planning to let more than 40 per cent of its staff go, citing improved productivity from using AI tools. The stock rose 20 per cent after hours. Whatever you think about the long-term impact of AI on the economy, it’s clear that information-processing industries are changing. Email us: unhedged@ft.com.

Valuations

Crikey, look at Korea’s stock market:

The Kospi is up 50 per cent in two months and 150 per cent in the past year. I can’t think of another major stock market that had ever risen that fast. And before this glorious summer, the winter was long: Jim Reid of Deutsche Bank notes that in inflation-adjusted terms the Kospi returned to its 1989 high only last September. The run is backed by good economic growth, corporate governance reform and overwhelming exposure to the semiconductor industry — Samsung and SK Hynix account for half the market (Unhedged discussed all three factors back in November).

Inevitably, the index has become much more expensive. Its forward price/earnings ratio has risen from nine to 17 in a year. Reid runs a model portfolio which leans into inexpensive indices, relative to the global average, and leans away from expensive ones. The Kospi has now moved from the cheap to the expensive group. “Over the long run, valuation wins out handsomely, so this shift is worth bearing in mind,” he writes. Unhedged agrees, and the comment got us thinking. We have written a lot about global stocks’ valuation discount to US stocks. After a good period of relative performance for global stocks, how are the discounts holding up? Well:

Emerging market stocks have given up much of their valuation edge, but the discounts for Europe (Stoxx 600) the UK (FTSE 100) and Japan (Topix) have remained wide and fairly stable, while the emerging market discount has tightened some. This looks like a rebalancing opportunity for long-term investors — particularly those who believe the rotation away from tech and towards “old” industries, driven by AI, is for real. The S&P 500 is still a third tech. The Stoxx 600, for example, is 7 per cent tech, and its biggest sectors are industrials and healthcare. As my colleague Leo Lewis recently pointed out, Japan is crammed with AI-resilient stocks, too.

But there is another, perhaps more attractive way to rebalance towards cheap stuff: US small and mid-caps. Here are their discounts:

Small and mid-cap US stocks may be at a smaller discount to big US stocks than the global indices in absolute terms — 20 per cent or so versus 30 per cent or so. But in historical terms, as the chart above shows, they are cheaper. Small and mid caps traded at part or even a premium to big caps before tech shares went bananas post-Covid. That is never true of the global indices. And the smalls and mids have the AI-resilient characteristics; the mid-cap index is a quarter industrials. Unhedged still likes this stuff.

10-year Treasuries: sniffing out risk?

There has been a pretty sharp move down in the 10-year Treasury yield this month:

This is not just down to lower inflation expectations. Of the 25 basis points in yield reduction, 15 basis points come from real yields (as proxied by inflation-indexed Treasuries). At the same time, the yield curve has flattened meaningfully — the yield difference between the 10-year and the two-year Treasury has tightened by 14 basis points.

What’s the message here?

Calvin Tse of BNP Paribas thinks Treasuries are picking up a geopolitical risk premium, driven by fears about a conflict in the Middle East. Brent crude has risen from $61 to $71 this year, and that explains the flattening of the curve: worries about higher inflation keep the short end anchored, while the threat to growth from a supply-driven rise in the oil price pushes the long end higher.

Longtime readers will know that this column tends to be dismissive of Donald Trump’s threats. The market usually is, too. But Tse thinks that after the president’s successful adventure in Venezuela, the market is pricing in a possibility the build-up of US forces in striking distance of Iran is more than just theatre.

Tse adds that option skew — the relative pricing of put and call options on long Treasuries — is reflecting some risk aversion, too. It’s usually cheaper to buy calls on long Treasuries than puts, but recently the price has equalised, as it tends to do at moments of fear and turmoil.

Ed Al-Hussainy, the longtime rates svengali for this newsletter, cautions against reading too much into the move. But he notes that it might reflect the shift away from tech stocks and towards “value” sectors. “From a portfolio perspective, when you switch from growth to value equities, you shorten the duration [interest rate sensitivity] of your portfolio,” so it makes sense to add some duration back by buying long-dated Treasuries.

As we like to do in confusing market moments, we’ll be keeping our eyes out for further developments in the Treasury market.

One good read

Brr.

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