When it comes to predicting the market's overall future direction, conventional indicators are of next to no use at all

INVESTMENTS

Who said that stockbrokers never produce any worthwhile investment research? Professional fund managers will quickly tell you that the tons of stockbroker research that pours into their offices every day is second- rate and worthless. The bulk of it ends up, unread and unwanted, in the wastepaper basket.

Is that fair? My impression is that brokers' research is actually now rather better than it was - certainly better edited and laid out, but also more rigorous and professional in its analysis.

There are occasional gems to be found amidst all the dross. This week, for example, I have been poring over a fascinating piece of work from James Capel, one of the stronger research-led brokers still left in the City.

What Capel's set out to test was what use conventional market valuation measures are in assessing the likely future direction of the stock market. Most investors are familiar with the traditional value indicators, such as a dividend yield, the P/E (price/earnings) ratio and the gilt/equity ratio.

More sophisticated investors may also now be looking at other indicators such as discounted cash-flow models, advance/decline ratios and so on. There is really no shortage of candidates and everyone has their own favourite.

But do any of them really have any value? For comparing individual shares, the standard valuation measures such as yield and P/E ratios are clearly helpful. But when it comes to predicting the market's overall future direction, the answer - Capel's research confirms - is that they are of next to no use at all. In fact, they may be positively misleading!

Take Wall Street, for example. The dividend yield of the market is now, as has been pointed out here many times, lower than it was before either the 1929 or 1987 stock market crashes. But that has not stopped the market powering ahead. Those who failed to be fully invested in Wall Street last year have paid a high price in missed opportunity since.

The same goes for the market's P/E ratio, says Capel's. In 1992, this reached a near all-time high, with prices on average nearly 23 times current earnings, roughly double the long-run historical average. Yet those who took that as an unmistakable sell signal would have missed out on an even bigger advance than those who waited for the dividend yield to drop below 3 per cent.

The reason is that whatever signal the P/E ratio may have been giving, in the event it was drowned out by other, more powerful influences - notably, in the case of Wall Street, the start of a strong surge in company profits and the relentless decline in both short and long-term interest rates.

A similar story can be told for nearly every other traditional market indicator in all the world's main markets. One that has done quite well, Capel's finds, is the ratio between the yield on short-dated gilts and the average dividend yield on the FT All-Share Index.

Every time, bar once, that this ratio has risen above 2.5 times, it has marked a peak in American share prices.

But, alas, even this seemingly robust indicator has its flaws. It's been good at calling the top of the market, but has given absolutely no warning of any of the market's troughs during the same 23-year period.

The general conclusions of Capel's statistical analysis are:

That no single indicator of market value has any real predictive power;

That although all measures eventually revert to their long-term average level, you cannot safely assume that they will do so on any one or two- year time horizon;

That the most powerful force at work in shaping equity values around the world is the level of interest rates, but even they only begin to have predictive powers if you already know where we are in the current investment cycle. In which case, of course, who actually needs them?

A blunter way of putting this conclusion is to say that "market timing" - trying to guess the future level of the stock market - simply does not work. Most investors, I suspect, are well aware of this, if only intuitively. The scientific evidence is certainly irrefutable. The Capel study is only the latest to underline this point.

But will it stop people trying to have a go at market timing, using whatever indicators they want? Of course not. Private investors do not have the inclination and professional fund managers have no freedom to stop trying to call the market's turns.

The latter are judged by and remunerated by their performance against the market as a whole and they have no choice but to try and beat it from year to year.

The reason I applaud James Capel for its outstanding latest piece of research - it is thoroughly analysed and full of fascinating historical detail - is the fact that the research has been produced by the broker's strategy team.

What is their job? To advise their professional institutional clients on where the market will be in six months to a year's time (for the record, the Capel's strategist Peter Oppenheimer and his team think that both Wall Street and the London market have further to go and are still in an earnings-driven phase).

It may be impossible, but at least the Capel boys are prepared to give this thankless, if not impossible, task their best shot.

Have you tried new the Independent Digital Edition apps?
Life and Style
ebookNow available in paperback
ebooks
ebookPart of The Independent’s new eBook series The Great Composers
News
Details of the self-cleaning coating were published last night in the journal Science
science
News
Approved Food sell products past their sell-by dates at discounted prices
i100
News
Life-changing: Simone de Beauvoir in 1947, two years before she wrote 'The Second Sex', credited as the starting point of second wave feminism
peopleHer seminal feminist polemic, The Second Sex, has been published in short-form to mark International Women's Day
News
i100
Arts and Entertainment
The beat is on: Alfred Doda, Gjevat Kelmendi and Orli Shuka in ‘Hyena’
filmReview: Hyena takes corruption and sleaziness to a truly epic level
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs General

    Recruitment Genius: Finance Assistant / Credit Controller

    £16000 - £18000 per annum: Recruitment Genius: They are an award-winning digit...

    Ashdown Group: Senior VMware Platform Engineer - VMware / SAN / Tier3 DC

    £45000 - £55000 per annum + benefits: Ashdown Group: Senior VMware Platform En...

    Recruitment Genius: Purchasing Assistant

    £10000 - £16000 per annum: Recruitment Genius: A distributor of specialist ele...

    Recruitment Genius: Sales Ledger Assistant

    £17000 - £19000 per annum: Recruitment Genius: A distributor of specialist ele...

    Day In a Page

    Homeless Veterans campaign: Donations hit record-breaking £1m target after £300,000 gift from Lloyds Bank

    Homeless Veterans campaign

    Donations hit record-breaking £1m target after huge gift from Lloyds Bank
    Flight MH370 a year on: Lost without a trace – but the search goes on

    Lost without a trace

    But, a year on, the search continues for Flight MH370
    Germany's spymasters left red-faced after thieves break into brand new secret service HQ and steal taps

    Germany's spy HQ springs a leak

    Thieves break into new €1.5bn complex... to steal taps
    International Women's Day 2015: Celebrating the whirlwind wit of Simone de Beauvoir

    Whirlwind wit of Simone de Beauvoir

    Simone de Beauvoir's seminal feminist polemic, 'The Second Sex', has been published in short-form for International Women's Day
    Mark Zuckerberg’s hiring policy might suit him – but it wouldn’t work for me

    Mark Zuckerberg’s hiring policy might suit him – but it wouldn’t work for me

    Why would I want to employ someone I’d be happy to have as my boss, asks Simon Kelner
    Confessions of a planespotter: With three Britons under arrest in the UAE, the perils have never been more apparent

    Confessions of a planespotter

    With three Britons under arrest in the UAE, the perils have never been more apparent. Sam Masters explains the appeal
    Russia's gulag museum 'makes no mention' of Stalin's atrocities

    Russia's gulag museum

    Ministry of Culture-run site 'makes no mention' of Stalin's atrocities
    The big fresh food con: Alarming truth behind the chocolate muffin that won't decay

    The big fresh food con

    Joanna Blythman reveals the alarming truth behind the chocolate muffin that won't decay
    Virginia Ironside was my landlady: What is it like to live with an agony aunt on call 24/7?

    Virginia Ironside was my landlady

    Tim Willis reveals what it's like to live with an agony aunt on call 24/7
    Paris Fashion Week 2015: The wit and wisdom of Manish Arora's exercise in high camp

    Paris Fashion Week 2015

    The wit and wisdom of Manish Arora's exercise in high camp
    8 best workout DVDs

    8 best workout DVDs

    If your 'New Year new you' regime hasn’t lasted beyond February, why not try working out from home?
    Paul Scholes column: I don't believe Jonny Evans was spitting at Papiss Cissé. It was a reflex. But what the Newcastle striker did next was horrible

    Paul Scholes column

    I don't believe Evans was spitting at Cissé. It was a reflex. But what the Newcastle striker did next was horrible
    Miguel Layun interview: From the Azteca to Vicarage Road with a million followers

    From the Azteca to Vicarage Road with a million followers

    Miguel Layun is a star in Mexico where he was criticised for leaving to join Watford. But he says he sees the bigger picture
    Frank Warren column: Amir Khan ready to meet winner of Floyd Mayweather v Manny Pacquiao

    Khan ready to meet winner of Mayweather v Pacquiao

    The Bolton fighter is unlikely to take on Kell Brook with two superstar opponents on the horizon, says Frank Warren
    War with Isis: Iraq's government fights to win back Tikrit from militants - but then what?

    Baghdad fights to win back Tikrit from Isis – but then what?

    Patrick Cockburn reports from Kirkuk on a conflict which sectarianism has made intractable