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Outlook: Stock Buffeting

THE "HOME SPUN" wisdom of Warren Buffet is now such a cliche as to have grown really rather irritating. None the less, we have to assume that this most celebrated of investors knows a bit more than the rest of us about the the black arts of stock market investment, so when he says that the long, long bull market which has so enriched him and his followers has effectively finished, that stock prices over the next 17 years cannot possibly live up to the public's expectations of them, we ought to sit up and take notice.

Of course, there is nothing in the least bit new or original about this view. Mr Buffet along with many others has himself been touting the belief that there is little if any value left in US stock markets for some years now, which is one of the reasons he's so utterly missed out on the boom in technology stocks. Never invest in anything you don't fully understand is a piece of home spun advice that has served him particularly badly in recent years. However, his latest musings on the subject, in the present issue of Fortune magazine, are made in particularly compelling form, and no excuses are offered for repeating them.

Mr Buffet notes that the US bull market of the last 17 years since 1982 was caused primarily by three things. Declining interest rates is the most important factor. This in turn has produced a sustained, if unspectacular rise in corporate profits, both in nominal terms and as a proportion of GDP. And finally there is market psychology. Once a bull market really takes hold, everyone eventually realises that it is a mistake to be out of stocks and piles in.

According to Mr Buffet, the growth that has taken place in the underlying economy during this period has been almost irrelevant. If interest rates are high and corporate profits low, the economy can grow as much as you like and still it won't have any effect on the value of shares.

Looking in the rear view mirror of the last 17 years, as Mr Buffet likes to put it, investors can only see rising stock prices and they have come to expect big rates of return as a result. Unfortunately, argues the Sage of Omaha, they are going to be disappointed. Shares cannot continue rising at the old pace, he argues, unless interest rates keep falling and corporate profits keep rising as a proportion as GDP. On both counts this is unlikely in the extreme.

Ah, say the optimists. Mr Buffet displays his age, for what he has forgotten is the transforming powers of the internet and the new economy, which will raise productivity and generate untold new wealth. True enough, he doesn't mention the Net once by name, but he does note in passing how few people ultimately got rich from some of the other industrial revolutions of the 20th century - aviation, automobiles, and even radio and TV manufacturing. Quite so.