Friday, November 21, 2008

Diminishing ratios, booming yields - great opportunity?

(FT Alphaville) With all the carnage in the markets, perhaps it’s no surprised P/E ratios are on the decline. What’s impressive is by how much.

Note this chart from UBS today:

PE ratios

Most markets, they say, are now trading at or very close to single-digit forward P/E multiples.

Meanwhile, yields on junk bonds are at their highest since the 1930s.

Junk bonds

All this, say UBS, is a signal to be loading up on equities and corporate bonds, or rather that “many ‘risk’ assets nevertheless offer seemingly attractive return prospects into 2009-2010″.

The rationale:

While undemanding valuations provide some support for equities, earnings uncertainty and risk aversion remain very high. Thus, ‘value’ comes at a cost—extreme volatility. Our sole regional preference lies with the US market.

And for corporate bonds:

Corporate credit yields imply default rates far above previous cyclical peaks, and offer good prospective returns, especially when relatively low volatility and low fixed income returns elsewhere are taken into account. We remain overweight in US and Eurozone high-grade credit, as well as a small overweight in US high-yield corporate bonds.

All very well, but let’s not forget - as Keynes said - the markets can stay irrational longer than you can stay solvent.

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