Pundits don't eat humble pie
Saturday 12 January 2002
Well, how upbeat are you feeling? The Christmas and New Year holiday is a traditional time for financial housekeeping and also what has become the annual pantomime of investment professionals presenting their predictions for the coming year.
Well, how upbeat are you feeling? The Christmas and New Year holiday is a traditional time for financial housekeeping and also what has become the annual pantomime of investment professionals presenting their predictions for the coming year. This is a game in which the spirit of Dr Pangloss, Voltaire's perennial optimist, rides unchallenged.
No matter how terrible the economic outlook, no matter how poor the track record of your predictions last year, it is simply not part of the repertoire of any self-respecting financial services game to be anything but doggedly cheerful about the prospects.
It is going to be interesting to see how the fund managers and brokers choose to sell their wares this year. The past-performance figures which used to figure so prominently in the marketing literature are not only more widely recognised as being poor pointers to the future, but also are not showing the kind of eye-popping results that lend themselves to triumphalist celebration.
A glance through the specialist investment magazines tells its own story. The most striking feature is simply that there are far fewer advertisements of any kind. Few fund advertisements mention their absolute long-term performance. The emphasis this year is either on their relative performance, or on other less quantitative features. Since so many funds are under water on a three- as well as one-year view, this is not surprising. Bond funds have been the saviour for many fund management groups in the past 18 months, and have done OK, though the double-digit annual returns bonds have achieved over the past five and 10 years will be almost impossible to repeat from where interest rates are today.
Professional market forecasters are less cocksure. As far as one can tell, not one of the highly paid strategists at any leading broking or fund management house publicly predicted a year ago that the UK or US market would fall in 2001, let alone that it would be a year when a genuine global bear market in equities developed, the like of which we have not seen for some time.
The events of the past year have been unforgiving across the board. No less a guru than Abby Cohen, the high priestess of US market strategists at Goldman Sachs, failed to spot the scale or extent of the market downturn. Her prediction that the US market would end the year at 13,000 was one of the more egregious of the missed forecasts.
Admittedly, there is little evidence of pundits overdosing on humble pie. Most are still resolutely bullish again this year, predicting that in 12 months the UK and US markets will be higher than today. This is a better bet than it was a year ago, not least because three years of successive equity market declines are rare in modern financial history.
What is notable, looking at the tables of market returns by country and region, is that the only developed country stock market of any size that did anything but fall last year in local currency terms was Austria, which managed a rise of 0.4 per cent. A few emerging markets did register gains, appropriately in the Year of the Great Bear, the Russian stock market turned in one of the best performances, but overall experience in 2001 underlined two points investors forget at their peril.
One is that the biggest single influence on the returns your investments will achieve over any time period is the behaviour of the market. It is comforting to think that the skill of your fund manager or adviser will immunise you against market risk, but that is largely an illusion. The second reality is the confirmation that globalisation has finally arrived in world financial markets, just as the rhetoric of the past few years has told us it would. To paraphrase George Bush, investors can run, but they cannot easily hide from global bull and bear markets.
Probably the biggest gainers of the past 12 months have been hedge funds. Huge amounts have flown into them in the past 12 months, and every man and his dog in the fund management business wants to provide or sell you one. Ten years ago there were 300 hedge funds: today there are more like 6,000. One of the safest predictions you can make this year is that most of these hedge funds will disappoint investors.
What many investors are buying is not exceptional fund management skill, but a style effect which happens to have had a couple of good years of performance. What is more, investors are being asked to pay above-average fees to latecomers, because many of the best and most experienced hedge fund managers are not taking on new money, knowing too big a fund is an enemy of good performance. Barton Biggs, the veteran market watcher at Morgan Stanley, believes this is another bubble waiting to happen.
I am hopeful that the Sandler review of the way retail financial investments are structured and sold will come up with powerful recommendations for the introduction of greater transparency on fees and incentives. (It is absurd that you cannot buy a fund direct from unit trust providers without paying a front-end fee, which is nominally for advice you usually haven't sought).
There is certainly a risk that markets will have another bad downturn after the present rally has run its course, but that seems a far less clear-cut risk than a year ago, when the overhang of the 1999-2000 bubble had still had to be paid for. The world's stock markets are looking across the valley of what is bound to be a period of continued bad earnings and activity numbers to what valuations still imply is going to be a vigorous economic recovery soon.
Dr Sushil Wadwhani, an external member of the Bank of England's monetary policy committee, says investors' 10-year expectations of earnings growth have hardly changed, despite the market setback. Surveys suggest many investors still anticipate 15 per cent per annum compound returns from the stock market, roughly twice the growth rate implied by any rational interpolation of earnings growth, interest rates and risk premiums.
But there is nothing that says this continuing anomaly has to be rectified in 2002, or that there won't be sufficient volatility to create money- making opportunities for the nimble. I am emboldened enough to repeat my now rather stale prediction that the Japanese stock market will eventually turnhelped by strength in the euro and a weaker yen. What troubles me most is that there is still so much optimism. You need the opposite to have above-average confidence in the potential for above- average gains.
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