So which way next for the markets? Stock prices are supposed to be discounted for future news. As a result, it is often said that markets recover at the beginning of a recession – meaning the outlook is good.
Is that analysis right?
This morning, CNNMoney quoted Phil Orlando, chief equity market strategist at Federated Investors, as saying: “Typically in a recession, the stock market bottoms when it perceives the slowdown is about halfway or three-quarters of the way through. Investors decided they’ve had enough and start pushing stocks higher before the news improves. But this time around, investors will need to see the evidence first.”
Meanwhile, in an article on the Interactive Investor site, Ken Fisher of Fisher Investments argued: “Bear markets arrive when investors run to the sidelines because things seem bad without potential redemption – basic human nature causes many to rationalise a way to believe misery will endure and progress remain dormant forever. These same folk end up missing the initial surge of the next bull market. Fact is, today doesn’t much matter. Today’s fundamentals were priced in long ago. Markets constantly look way into the distant future – so should you.”
It is also true to say the value of companies projecting profits for next year (p/e ratio) is on the cheap side.
According to data from Thomson Datastream and dug out by Capital Economics, the average p/e ratio for the Datastream All Share Index for the last 20 years is 16.3. Over the last ten years the average is 17.3; as of November 19 it was just 8.3.
But there is a snag with that way of looking at things. These p/e ratios are based on projected profits. If this economic crisis has been characterized by one theme throughout, it is that analysts, economists and forecasters have consistently underestimated how bad things were going to get.
Who is to really say what next year’s profits will be? They could end up being a lot lower than current projections.
The same argument applies to the belief markets recover before the economy does. Nobody really knows when the economy will recover.
Capital Economics has suggested that bond yields and equity prices have more or less been falling in tandem. And since interest rates are expected to fall further in the UK, one assumes bond yields have further to fall, too. Capital Economics also reckons the FTSE 100 is currently priced for a modest recession – and yet more and more people are saying the recession will be anything but modest.
On the other hand, share prices are supposed to be based on a prediction of all future dividends for a company, discounted to provide a net current value. Bad as this recession may be, the long-term potential of most businesses has surely not been affected by that much.
Warren Buffett once said: “My favourite time for holding a stock is forever.”
On the other hand, Keynes once said: “The market can remain irrational longer than you can remain solvent.”
If you take a long-term perspective, then it seems markets may well be cheap. But, how long is long term? Remember, the most famous thing Keynes said was: “In the long run we are all dead.”
Comments
Trackbacks