By Michael Tsang and Sarah Jones
Jan. 2 (Bloomberg) -- The steepest yearend slump in global stocks since 2000 left equities with the cheapest valuations in more than 30 years as inflation accelerated and the U.S. economy showed signs of slowing.
AT&T Inc. and other telephone company stocks became the least expensive group in the MSCI World Index compared with the cash they produced. Shares of ABB Ltd., the world's largest builder of power networks, and competing engineering companies failed to keep pace with earnings growth. A majority of Japan's companies trade at less than half their net assets as profits and wages contract in the world's second-largest economy.
``Equities on a valuation basis should be worth more,'' said Robert Doll, 53, who oversees $1.3 trillion as chief investment officer of global equities at BlackRock Inc. in Plainsboro, New Jersey. ``The devil's advocate argument says, `But wait a minute, that's based on some notion of earnings and how do you know the earnings are going to be there?' That's going to make it tougher for markets.''
Stocks fell to the lowest last month relative to bonds since the 1970s according to the so-called Fed model, which was cited by former Federal Reserve Chairman Alan Greenspan a decade ago. Equities yield 4.17 percentage points more in projected earnings than 10-year government bonds paid in interest at the end of 2007, according to an analysis of 29 countries by New York-based Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm by market value.
September 1974
The gap is now the widest since September 1974, when adjusted for volatility, the data show. The last time the spread was wider, equities outperformed debt by 24 percentage points in the next 12 months, according to Lehman.
The MSCI World dropped 2.7 percent last quarter, trimming its 2007 advance to 7.1 percent. The last time the gauge of 23 developed markets posted a decline for the final three months of the year was in 2000 as the Internet bubble burst.
The Standard & Poor's 500 Index, the benchmark for American equity, rose 3.5 percent in 2007, the second-smallest annual advance of the five-year bull market. The Dow Jones Stoxx 600 Index of European companies and Japan's Nikkei 225 Stock Average snapped four-year winning streaks, losing 0.2 percent and 11 percent, respectively.
Equities may get even cheaper should financial firms' $97 billion in writedowns and credit losses related to the collapse of the subprime mortgage market cause the world's biggest economy to shrink. U.S. gross domestic product may grow by 1.5 percent this quarter and 2.1 percent in the April-to-June period after slowing to 1 percent in the last three months of 2007, the median forecast in a Bloomberg survey of economists showed.
Recession Predictions
The U.S. and Japan will fall into recession this year, according to New York-based Morgan Stanley, the second-largest U.S. securities firm by market value. Goldman Sachs Group Inc., its bigger rival, says ``aggressive'' action by the Fed is needed to prevent a contraction.
Inflation may prevent central banks from reducing interest rates enough to keep the economy from shrinking, according to Ryan Atkinson, 35, who helps oversee about $400 million at Balestra Capital Ltd. in New York. ``There will be a recession, and it could be significant,'' he said.
U.S. consumer prices rose at an annual rate of 4.2 percent through the first 11 months of 2007, the most in 17 years on an annualized basis. Inflation in Europe jumped 3.1 percent in November, the fastest annual pace in more than six years.
`Period of Uncertainty'
Stephen Docherty, who helps oversee about $194 billion at Aberdeen Asset Management in Glasgow, said concern that growth will slow made telephone stocks a bargain even as competition with cable providers increased. They are cheap in part because the telephone companies are boosting cash payouts, he said.
Phone stocks trade at an average 6.56 times the cash they generate, a 31 percent discount to the MSCI World and the cheapest among the 10 industries included in the benchmark.
San Antonio-based AT&T, which announced plans last month to buy back $15.2 billion of shares and raised its dividend 13 percent, is valued at 8.16 times cash flow. Deutsche Telekom AG, Europe's largest telephone company, lifted its dividend for the first time in two years. The Bonn-based company trades at 4.24 times the cash it generates, less than half the average of developed-market companies.
Cash flow at telephone companies is ``probably more predictable in this period of uncertainty,'' said Docherty.
China, India Projects
ABB and competing builders of power networks and transportation and communications systems for developing nations are inexpensive compared with their rate of profit growth.
Earnings at Zurich-based ABB increased more than 85 percent in 2006 and the first three quarters of 2007, boosted by electricity projects in China and India. Gary Steel, an ABB board member, said in November that demand was unaffected by the global jump in credit costs.
ABB's so-called PEG ratio, which compares the stock's price- to-earnings ratio with projected profit growth, is 0.67 based on estimated earnings. That's lower than the median of 1.39 for the S&P 500. The lower the number, the cheaper the stock.
Larsen & Toubro Ltd. of Mumbai, India's biggest engineering company, has a PEG ratio of 1.02. Seoul-based Hyundai Engineering & Construction Co., South Korea's largest builder by market value, trades at 0.4.
Slower Growth
Infrastructure companies collect a ``royalty on increasing affluence,'' said David Winters, 45, who manages about $3 billion as chief executive officer at Wintergreen Advisers in Mountain Lakes, New Jersey. ``The risk is what happens if all these emerging markets slow down, which they will at some point.''
India's plan to double spending on roads, ports and other infrastructure by 2012 will ``set the stage'' for 9 percent economic growth, Montek Singh Ahluwalia, deputy chairman of India's state-run Planning Commission, told the World Economic Forum's India summit in New Delhi last month.
India, Asia's third-largest economy after Japan and China, plans to spend about $500 billion in the next five years to strengthen public facilities. China currently invests about $150 billion on public works each year.
Jean-Marie Eveillard, who manages the $21.8 billion First Eagle Global Fund in New York, says share prices in Japan have slumped so much that he's a buyer even though consumer prices fell for eight months last year, corporate profits dropped for the first time in five years and wages declined every month except one in 2007.
`Graham-Type Stocks'
The Topix index plummeted 21 percent between February and November last year, making Japan the first of the world's 10 biggest stock markets to enter a bear market. The plunge left 2,007 of the 4,009 companies on Japanese exchanges with market values less than their so-called book value, or assets minus liabilities, data compiled by Bloomberg show.
That suggests a majority of Japanese companies would fetch more if shareholders fired their executives and sold all the assets.
``Japan is the only developed country left where you have what I would call Benjamin Graham-type stocks,'' said Eveillard. Graham developed value investing in the 1930s and his disciples include billionaire Warren Buffett, the chairman of Omaha, Nebraska-based Berkshire Hathaway Inc. ``You're paying less than nothing for the businesses.''
Book Value
Eveillard is targeting shares of companies with property holdings in Tokyo because commercial land prices are rising for the first time in 16 years and office vacancies are falling to the lowest in at least six years. He holds Tokyo-based Toho Co., Japan's biggest film company, which hasn't marked up the value of its real estate in more than 50 years.
Toho, which had a 16 percent drop in fiscal first-half profit, owns property and buildings in central Tokyo that are worth about 582.6 billion yen ($5.22 billion), according to Sydney-based investment bank Macquarie Group Ltd.
That's 16 times more than the book value of 35.8 billion yen and exceeds Toho's market capitalization of 477.2 billion yen. Adjusting for the market value of its property holdings, Toho is valued at about 0.6 times the company's total net assets, according to Bloomberg calculations.
Cooperation among central banks will make global stocks more alluring by keeping economies growing and lowering borrowing costs for banks, according to Schroders Plc's Alan Brown. The cost of borrowing in dollars, euros and pounds has declined since policy makers from the U.S., U.K., euro region, Switzerland and Canada announced a combined effort last month to ease a logjam in interbank lending.
``The valuations we're seeing are laying the foundations for a good rally in stocks just as soon as this uncertainty in credit markets dissipates,'' said Brown, 54, who oversees about $280 billion as head of investments at Schroders in London. ``The wild card out there is, what if we don't get back to normal?''
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