Secrets of Success: The bull is tiring? On the contrary

So where will the market end up this year? My longstanding correspondent Ken Fisher, the West Coast money manager and Forbes columnist, has once again been turning his attention to this issue, using the contrarian forecasting methods that have served him well in the past, and which I referred to a couple of weeks ago when declining (on the grounds of cowardice) to make my own predictions for the year ahead.

His methodology, which is not as frivolous as it might at first sound, involves taking a detailed look at the predictions of a wide range of well known or influential market forecasters and finding the holes in the range of outcomes.

If past experience is any guide, the one thing you can be sure about, says Mr Fisher, is that the stock market will not end the year anywhere near where the majority of forecasters are predicting it will. Apart from the strong empirical evidence that this is a well-founded matter of fact, the theoretical reason why this bizarre approach might actually have some force lies in finance theory. If the forecasters are genuinely influential and believe in their projections, then it follows that their confidence will already have been priced into the market by the time the forecasts reach the public's ears.

In fact, the track record shows that the consensus opinion of forecasters in most years is not even right about the direction of the market, let alone the scale of the likely change. A year ago, you will recall, most opinion was still positively gloomy about the outlook for the equity markets. In the end, it turned out to be a very good year, with the FTSE All-Share index returning around 20 per cent and the US market doing even better (comparisons are confused by the sharp movement in the dollar-sterling rate).

Mr Fisher admits that his own predictions, even with the help of his well-tried methodology, are not perfect. He was too early in calling an end to the bear market in 2002, and last year underestimated the extent to which the market would rise, though he was right about the case for a recovery. This year he remains just as strongly convinced that the recovery in share prices will continue. His central estimate is that the market will rise something like 20 per cent this year, which is comfortably ahead of the consensus opinion.

There are a number of reasons why he thinks that this will happen, all of them (to me) perfectly credible. The election cycle is favourable; the Federal Reserve is unlikely to get too busy on the interest rate front as a result (whatever you read into its recent change of wording at the last Open Market Committee); and there is no evidence (he says) that a combination of strongly reviving economic growth and low interest rates cannot co-exist in a calendar year, as many pundits would have you believe.

That happy combination has happened in the past and can well happen again.

Using the same methodology on interest rates as he does for markets, Mr Fisher expects that three-month Treasury bills will end the year yielding less than 1 per cent and 10-year bond yields will finish the year at around 4.5 per cent. In both cases this is a full 1 per cent below the mainstream consensus forecast. Of course, in the medium term, the huge monetary stimulus that has been pumped into the world economy is bound to lead to renewed inflationary pressures, especially if growth continues to pick up at a strong rate, which in turn will require a flattening of the yield curve as short term rates are finally increased.

But one clear lesson of market history, according to Mr Fisher, is that such linkages rarely run as synchronously as economists would have you believe.

While many fund managers think we are heading for a period of flat returns over the next ten years, in practice the market will continue to be volatile. As the table suggests, years that produce average returns - between 0 and 20 per cent per annum - are the exception rather than the norm in the UK market. They happen barely three years in every ten. The same goes for all the leading equity markets in the world. The average spread between the best and worst years in a decade is 56 per cent.

Another facet of market concerns which supports a contrarian approach is that the public perception of wrongdoing in the capitalist process continues to widen. The net of apparent wrongdoing has moved on from large companies, investment banks and accountants to encompass mutual funds (eg the market timing scandal in the States) and even intermediaries (witness precipice bonds, split capital trusts and other cases). In all these cases, the scandals only affect a small minority of each class of business, but the idea that there are rotten eggs all through the financial system is a common feature as new bull markets get under way.

Mr Fisher, in other words, remains convinced that what we are seeing is a new bull market, not just an upward tick in an ongoing bear market.

As an investor, you pays your money and takes your choices, but in the short run, as I have noted earlier, there is plenty of room for this market rally to continue for a while yet, however overvalued the US and UK markets may be on fundamental grounds.

jd@intelligent-investor.co.uk

Comments