Secrets Of Success: I'm bullish, but feel free to disagree
Saturday 09 December 2006
Having said last week that I remain intuitively bullish about short-term prospects for the stock market, it is only fair to report that my instincts are not shared by some very senior figures in the professional investment world. As they include the likes of Anthony Bolton, Jeremy Grantham and Derek Stuart, three of the biggest names in the business, you are entitled to regard my opinion as dangerously eccentric.
At a conference organised this week by my publication Independent Investor, there was a frank and fascinating exchange of views about the risks to investors in the current stock- market environment, with Grantham and Bolton making the case for caution. Two of Jupiter's best fund managers, Philip Gibbs and Ian McVeigh, vigorously led the contrary case.
In fact, the argument about the market, it seems to me, is as much about timing as it is about direction. If your time horizon is short term, as in practice it is for many fund managers, periods such as the current one are full of danger. Nobody wants to be caught positioned for a bull market when the market decides to take a dive, but being left behind in a strong bull run is an even worse outcome.
The latter can be seriously career-threatening, while the former rarely produces such a severe outcome. One point Grantham made forcefully in his impressive hour-long analysis was that managing career risk among professional investors is one of most powerful drivers of market behaviour (arguably, in his view, the one constant).
For private investors, the career-risk arguments do not apply, but the dangers of missing out on strong market moves are real. The statistics show that being out of the market during the late stages of a bull market can be costly. If you missed the 20 best days in post-war history, the return you would have made from stocks would have fallen very sharply - enough, in fact, to remove most of the excess return that stocks have historically provided over cash.
If your horizon is genuinely long-term, however, as a private investor the risks of following common sense - trimming equity exposure when markets are expensive, and adding to it when they are cheap - diminish. There is no need to chase markets higher just for fear of losing out. It is never an easy call to make, but realism does produce its own rewards too.
The current phase of the market will prove, I suspect, one of those interesting career-threatening phases in stock-market history for professionals when the head points to stocks experiencing a setback, while the heart (or the gut, if you prefer,) suggests that it might well continue. As Bolton pointed out, the current bull market is long in the tooth. Only one post-war bull market has lasted for longer than the current one, and real value opportunities are getting hard to find.
Medium-term prospects for stocks at their current valuation levels cannot be good, believes Grantham. His firm's projections, rooted in the principle of mean reversion, are that stocks in aggregate will most likely produce a negative return over a seven-year horizon (seven years being chosen because it is a period of time over which the direction of returns becomes far more predictable). Within this context, high-quality stocks and emerging markets stand out as offering the highest potential returns.
The fact that profit margins are so high - which is one of the props on which the current bull market is built - is by no means a promise of high future returns. In fact, profit margins are one of the most reliably mean-reverting series in economic history. Periods of rising margins are inevitably followed by periods when the trend reverses (it is called capitalism at work), though the timing of the turn cannot be known precisely in advance.
On the other side of the argument is the fact that there is little sign so far of a decline in corporate profits, despite the threat of an economic slowdown next year, and that price-earnings multiples have been falling rather than rising, which serves to make them look more attractive.
Compared to bonds and property, Gibbs pointed out, equities continue to look the most attractive asset class. M&A activity will meanwhile continue as long as the cost of debt remains so out of whack with the cost of equity.
With the world still experiencing a surplus of liquidity thanks to the controversial cheap-money policies of the Federal Reserve, and investors seemingly untroubled by risk, there may be good reasons for suspecting that today's bull run can continue for a while, irrespective of what happens in the longer term.
Grantham concedes that the third year of the US Presidential cycle is typically the best for shares (an effect, he noted, even more marked in the UK, far more in step with the US electoral cycle than with our own).
When markets have risen strongly, however, there has to be some catalyst to stop them in their tracks. They don't just die of their own accord. For the moment, we cannot see what that catalyst might be, which is why upward momentum can persist for some time. Sandy Nairn, another professional investor whose views I respect, says that risk is bound to re-emerge as a concern, but he suspects not just yet.
If there are still issues to be resolved about the overall level of the market, in style and sectoral terms the argument appears much less complicated. A clear message that came out of virtually every round-table presentation this week was that some of the best values in the market now are to be found in the telecoms, media and technology sectors, and that the large-cap, quality-stock story, flagged here for a year or so, remains as valid as ever. These are the very sectors that took the market so high in 2000 and then led it all the way down during the bear market that followed. Focus on the value opportunities in those sectors is unlikely to go unrewarded, whatever turn the market now takes.
A sparkling presentation from Ben Rogoff, one of the specialist fund managers at Polar Capital, convinced me that it is sensible to put some money back into the technology bear-pit.
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