“Is the AEX going to keep breaking records, or is the end in sight?”

Published on: 10 September 2021

Current issues in the field of economics, (responsible) investment, pensions and income: every week, an APG expert gives a clear answer to the question of the week. This time: chief economist Thijs Knaap on the stormy development of the AEX. “The 800-point mark is a good time to scratch your head and wonder.”

Shares have never been so expensive. On Monday, September 6, the AEX narrowly missed the "magic" mark of 800 points. Has equity become too pricey? Not really, Knaap says, because the prices reflect the good results of Dutch business. Moreover, other investment classes are also expensive. So, there are not a lot of alternatives. But you also can’t really say that the AEX cannot go down. “Is there any way this can get out of hand? Yes, if savers leave the market en masse again. There is a good chance that we will say afterwards: these valuations were too high.”


That 800-point mark is a good time to take stock of where we stand and to scratch our heads and wonder, according to Knaap. “For APG as an investor, the AEX is not that relevant. We invest globally, so we focus on the MSCI World Index. But the AEX has risen 27 percent this year, outperforming, for example, the S&P500, and it did much better than the MSCI Europe. Why? Because the Dutch economy is doing quite well - we came through the pandemic reasonably unscathed. In addition, technology companies carry a lot of weight in the AEX: ASML, ASMI, Adyen. Those companies have done very well this year. In that sense, the development of the AEX is simply a reflection of the positive Dutch corporate results.”


However, that is not the whole story. Because even if you take those great company results into account, the price/earnings ratios - the share price divided by the earnings per share - of AEX companies are high. Such a high price-profit ratio can mean two things: the share is overvalued, or investors expect a large increase in profits. The latter does not seem to be the case. So it is overvalued? Knaap: “I understand that the AEX companies are doing well, but the current valuations are very high. That makes future expectations of returns on shares low. As an investor, the first tool you use to determine whether a share is expensive or cheap is the price/profit ratio. But apart from that, there is also simply the question of supply and demand of course.”

Hard evidence
And that demand has clearly increased, while the supply of shares has not. According to Knaap, this has to do with a hefty influx of money in the stock markets. "Central banks are not in a hurry to tighten the money supply and during the corona crisis the support measures did not reduce most people’s incomes. At the same time, opportunities to spend money - vacations, eating out - decreased. This has led to huge savings surpluses. Savings currently yield nothing, so the assumption is that much of that money has ended up in equity markets. I don’t have hard evidence for this. But there is anecdotal evidence, for example, the difficulty many people had in opening an investment account. Normally, sharply rising demand - and thus sharply rising prices - are met with stock offerings by other investors. However, that is only partially the case now. In that regard, the recent paper by Ralph Koijen and Xavier Gabaix was an eye-opener for me. They argue that every euro that now flows into the stock market increases the total market value by 3 to 8 euros. So a relatively small increase in demand leads to a large increase in price. The cause of this disproportionate reaction, according to Koijen and Gabaix, is that large institutional investors - pension funds, insurers, index funds - are dominating the market today. They have a strategic investment plan to implement, with fixed allocations to equities. There has to be quite a shift in price for them to relinquish those pieces. Thus, a small increase in demand can lead to a sharp rise in price. Relatively small investors can therefore have a relatively big effect on the stock market.”

And at the same time, this relatively large influence is the risk of the current situation. Knaap: “If this model is correct, and savers want to get out of the stock market again, the market can move downwards just as fast - without the companies doing worse. And that also applies to the AEX.”