Stock market performance is both a function of economic performance and valuations. At low valuations, stocks can withstand a lot of bad news, while at high valuations they can fail to move higher on good news and crash on the same bad news that, at lower valuations, they would merely shrug to.Thus as Citi’s Robert Buckland highlights, stocks might be able to withstand a European sovereign crisis, given that they are trading at a historically low price to book valuation globally:
Robert Buckland @ Citi:
As equity valuations look reasonable, they should provide some protection against further disappointments. Right now, global equities trade on a trailing price to book of 1.8x, well below the 3x reached before the Asian crisis and the 2.7x reached before the recent financial crisis. Indeed, current levels are even well below the 2.1x reached before the Mexican crisis in 1995.
So, we think that further contagion in global equities will be limited from here.
[image url="http://static.businessinsider.com/image/4b8760b47f8b9a226c150300/image.jpg" link="lightbox" caption="" source="" alt="Chart" align="left" size="xlarge" nocrop="true" clear="true"]
It would be naive to not expect some kind of correction if a true European crisis unfolds, but the point is that any correction could be surprisingly mild. As shown above and barring 2009’s lows, stocks are already cheaper now, globally, than any time in the last two decades.
(Via Citi, Global Economic Outlook And Strategy, Robert Buckland, 24 Feb 2010)