Daring to be bears
Tuesday 06 July 1993
The bear case comes in three packages: charismatic, blunt, and numerate. A word about each.
The charismatic element has been provided by people such as Sir James Goldsmith, who is apparently switching a large part of his not inconsiderable fortune into gold. The argument seems to be mainly that the world has become a dangerous place and it is more important to preserve wealth than to make more of it. This could be dismissed were it not that George Soros has also indentified gold as an attractive investment, and gold has been extremely strong in recent weeks.
The run into gold may have nothing to do with Western investment perceptions, but may be stimulated by something like the Chinese inflationary situation. Nevertheless, when someone like Sir James does move it is silly not to take notice. Remember, he got the October 1986 crash right, selling in the summer at the top of the market.
The blunt comes in the form of a four-page paper doing the rounds of New York investment houses, and reported in the US press. It has been put together by three sceptics in New York fund management firms, who keep their names off the cover, doubtless for fear of retribution. It charts a number of similarities between the situation in the summer of 1929 and today.
For example, values are high on conventional p/e ratios at both times; there has been a secular bull market since 1982, broken only by the 1986 crash, which compares with the bull market that lasted from 1921 to 1929; then as now, too much commercial property was built for the available demand; at both times a lot of small-investor cash went into mutual funds; and in both periods few fund managers had experience of a serious bear market.
There are other parallels, but it is undoubtedly a crude message, for the parallels are never exact. However, the fact that the authors feel they have to go underground to make the bear case is itself slightly alarming. If fund managers feel they are not allowed by the thought police to go public on their fears, the market really is precarious. This suggests that some analysts may be acting against their own instincts because of pressure from their firms to keep the buyers coming.
A more numerate version of this bear case comes from one firm of advisers that does not try to sell securities: the editors of the Bank Credit Analyst in Montreal. This specialist financial consultancy has long charted cyclical trends in North American data, and its usual buy/sell indicators are flashing sell, or at least to use any strength to lighten positions.
It does not particularly believe that there is a crash coming, but it does believe that shares are overvalued relative to earnings prospects. This overvaluation could be worked off in a benign way. But as it says in the July issue: 'The main point is that the best is behind us in this bull market, the prospective returns at current price levels look poor compared with the risks, and that the market appears vulnerable to any negative shocks to confidence.'
None of this is mainstream. The mass of the New York investment community remains bullish. Take for example the view of Goldman Sachs. In its latest paper on World Investment Strategy it says: 'US equities remain significantly undervalued relative to inflation and interest rates', and it expects the market as a whole to rise by about another 9 per cent over the next six to 12 months. On projected p/e ratios, the market is close to past peaks and its dividend yield of 2.9 per cent compares with an average of 3.3 per cent at past peaks. But because both inflation and interest rates are very much lower than in previous cycles, Goldman believes these levels actually underprice the market this time.
What should someone sitting in Britain make of all this? As far as the US market is concerned the Bank Credit Analyst point seems the most sensible: that the best of the bull market is past and investors should accordingly be cautious. If there is a sudden burst of enthusiasm later this year and the market rises further, that should surely be a sign to invest in something else. But from a British investor's point of view the issue is one of contagion: to what extent will the end of the US bull market (whenever it occurs) damage UK equity prices?
It must to some extent, for US investors are an important influence here. Just yesterday Rolls-Royce was pointing out that overseas investors had nudged above the 29.5 per cent limit on foreign holdings in its articles, and steps have been taken to bring the percentage back down. Wall Street is frequently behind big share price movements in London.
Our economic cycle is running a year or so behind the US, so maybe there is still some way to run in the investment cycle too. But will the 'top' in New York be a signal for American investors to switch to London for that last year of the bull market, or will the blood be so deep that London will suffer too? The head says that because London values are more reasonable, it could survive bad news from Wall Street. The heart, alas, says something different.
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