Brokers who look beyond lunchtime

Economic Analysis
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The Independent Online
IT IS an old joke that in the financial markets a long-term view means after lunch. Yet anyone who thinks that the markets are invariably and unashamedly short-termist in their outlook should remember that when people buy government stock, they are making an implicit judgement on the trends of interest rates and inflation for the next five, 10 or even 25 years.

And some of the most successful equity investors - Warren Buffett and Sir John Templeton, for example - have achieved star status precisely because they have always taken a very long-term view.

But if "long-termism" is an attractive investment philosophy, it is a curiously ill-served one. The professional advisers rarely tackle long- term trends in financial markets.

Instead, the vast majority of brokers' analysis is devoted to stock-picking: the results of this or that analyst's visit to the other company; the instant comment on the results; the earnest tome examining every detail of a company's performance with projections on earnings for the next three years. Institutional investors must want this "buy of the week" approach or the brokers would not produce it. But it is pretty dissatisfying.

Looking further out, there is a certain amount of (very useful) examination of past long-term investment trends.

For example, in Canada The Bank Credit Analyst regularly looks at investment trends back to the Fifties (and sometimes to the turn of the century), and here the annual BZW Equity-Gilt Study goes back to 1918. But that is different from looking forward.

So it was encouraging to see a couple of exercises from London securities houses in the past week which do look at the big picture of the investment climate over the next few years.

One, Strategy 2000, comes from BZW. The idea is to look at the trends in the world economy over the next 10 years and then see which countries are likely to have a good run. Get the country right and you are at least more likely to get the investment right.

The study takes as a starting point some basic assumptions: that living standards in the OECD countries (though not in the world as a whole - see chart) will grow faster than in the Eighties; that there will be low inflation; that real primary product prices will rise; that trade imbalances will become more worrying; that "knowledge-intensive" industries will do better than others; and that the cost of capital is an important determinant of competitiveness.

The various countries are then ranked on each of these tests and their score added up.

The conclusions? The most interesting is that countries which have, in the Eighties, done rather badly will, in the Nineties, do rather well.

Winners include the "Anglo" countries and continental Europe minus Germany and Italy. Losers include (as well as those two) Japan. Top score goes to New Zealand, followed by the US, France, Norway, Mexico, the UK, Netherlands, Canada and Switzerland. Bottom is the Philippines, just below Germany, Japan and a clutch of newly industrialised countries including Taiwan, Indonesia and Thailand.

Whether this proves right or not is, of course, open to question. But BZW has been running this exercise since 1991 and its portfolio weighted by favoured country has significantly outperformed the world share index over this period. At the very least, it is a helpful challenge to conventional economic wisdom which seems still to over-emphasise the success of Japan and Germany and underestimate the fundamental strength of the US economy.

If getting the country right is half the battle, getting the cycle right must be the other half. Here the help comes from James Capel's new paper, The Anatomy of an Investment Cycle, which seeks to plot the cycle and tell us where we are upon it.

And the answer? It is a sophisticated argument because there are two cycles, the business cycle and the interest rates cycle, and at different times these have an effect on equities and fixed-interest investments. The equity cycle can be shown schematically - with rising share prices driven first by falling interest rates, then falling as interest rates rise, then rising again as economic growth pushes up profits, and then falling as growth peaks and profits fall back.

If this all sounds too easy, Capel applied this schematic vision of the equity cycle to the US market, picking out the stages of the various cycles since 1974.

That scheme is shown here: the US market now is well into the "equity III" phase, with at some period ahead the next recession heralding the time to switch into fixed-interest or into cash. But when? The final and bravest section of the Capel paper tackles this issue. Its conclusion is that most big markets are, like the US, now firmly into the equity III phase of the cycle.

The US has seen most of the rise in profits growth already and so is most mature. The peak in the cycle is, however, some way off. It is likely to come six months before the peak of the profits cycle, which Capel reckons will come towards the end of next year.

That suggests that the time to get out of US equities will be next spring.

The paper does not go further forward than that. But you could use the same schematic thinking and project the next cycle forward too. That would suggest that a year or so later, say spring 1997, it would be right to get back into US equities. And by the same token you could say that the time to get out of UK shares will be towards the end of 1996 - and the time to get back in, end-1997.

The obvious trouble with this sort of analysis is that, in a way, it is too easy. Everyone has access to the same information. It is not possible to call market movements with any accuracy because all cycles are slightly different. And they are different precisely because investors look at previous cycles and seek to profit from the knowledge of past patterns.

So investors need to modify their behaviour slightly. Here the brokers instil a little practical wisdom.

The US market has done so well this year that it might be time to switch out. It has already risen by the 10 per cent the brokers expected for the whole year. So grab that 10 per cent rise, stick the money on deposit for the rest of the year and you still have a money return of nearly 15 per cent or a real return of 11 per cent.

Since the average real return on equities is about 6 per cent, that 11 per cent cannot be bad.

Take these two exercises together, the strategic review of BZW and the cycle analysis of Capel, and you have a long-term investment approach covering most of the factors which affect share prices.

Of course someone has to do the stock-picking. But since all investment portfolios should be reasonably broadly based, the overall impact of stock- picking is going to be quite small.

My suggestion to the securities fraternity, therefore, is to take a few of the people away from the study of individual companies and put them on more longer-term research of economic and financial market trends.

This ought to make business sense too. It is a nice accolade to have a few star analysts in the Reuter ranking, but it gives more lasting added- value if a securities house can make a fist of getting clients into the right market at the right time.

It would also help nail the lie that markets care nothing about the long term - something which would do the investment community a power of good in the eyes of the rest of the world.

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