Several developments in recent weeks have persuaded Bare Talk that the global feel-good stock market rally that is under way is bound to be a false dawn.
According to The New York Times (25 April), six of the biggest banks in the US have set aside $36 billion for workers’ compensation: “Workers at the largest financial institutions are on track to earn as much money this year as they did before the financial crisis began, because of the strong start of the year for bank profits.” Two things are worth noting here. One is that there is an acknowledgement that banks had a strong start to the year for profits. That is questionable, at best, and plain wrong at worst. Second, it signals that banks are keen to restore the world that prevailed before 2007.
The industry views this crisis as similar to all asset price booms and busts of the past, except that it happened to be bigger and global. It has been dealt with a commensurately big and global policy response. Consequently, now it is time to go back to “business as usual”. This is further confirmed by a brazen assertion that Rodgin Cohen made recently. He is chairman of the law firm Sullivan and Cromwell Llp, and he was considered for the post of deputy treasury secretary in the Obama administration. In a panel discussion, he said that he saw nothing inherently wrong with the system and that the system would look more like what preceded the current environment than many believed.
Further, an index of risk aversion called the financial stress index, a gauge maintained by Bank of America comprising 12 financial market indicators, is at its lowest level since July 2007. In July that year, the real world, too, was way out of kilter and expatriate Indian housewives in Singapore were speculating in real estate. Now, these people have seen light (or been forced to see light) and are nowhere near as cocky and exuberant as they were in the summer of 2007. Yet, an index comprising financial market indicators has returned to its level of July 2007. What that tells the rest of us is that financial markets and their participants inhabit a planet different from the one the rest of us live on.
If financial risk appetite, as indicated by financial market indicators, is at that level, then the investment implications are obvious. It is one of the rare opportunities to sell financial assets, as it was then. Corporate insiders in the US are paying heed. They are selling their stocks at the fastest pace since…yes, 2007.
Admittedly, in March and early April, policymakers took some important steps. One was the announcement—no matter how flawed—of a “public private partnership” to purchase toxic assets from US banks. The Federal Reserve announced an aggressive programme to buy bonds, thus injecting money directly into the economy.
Also, the Group of Twenty meeting on 2 April agreed to put more money in the hands of the International Monetary Fund to support emerging economies in distress.
These aggressive measures might have prevented the global economy from falling off the cliff into the abyss, for now. But it is still hanging by a rope on the side of the rock. Hence, to see even acknowledged bears talk of further gains for US stocks is a bit puzzling. In the 1990s, even the Nikkei 225 stock index in Japan had two big gains of 43% and 55%, respectively, in 1992-93 and 1995-96. But these gains took nearly a year to achieve, whereas the Standard & Poor’s (S&P) 500 Index has gone up nearly 40% in eight weeks.
At the present level, any reasonable estimate of corporate profits for the S&P 500 companies in 2010 would show that the index is, if anything, a trifle overvalued. In the golden years of the US economy in the second half of the 1990s, operating earnings for S&P 500 were between $45 and $55 per share. In this decade, aided by loose monetary policy, unbridled debt and an oil price boom, financial and energy sector companies delivered record, if unhealthy and unsustainable, profits. Operating earnings per share surged to $75-85 per share during 2005-07. For 2010, analysts estimate operating earnings to be near $75 per share. It is up to readers to determine if this is reasonable and decide on their own investment stance accordingly.
First Global in India (Le Grand Fromage) has done some useful analysis to show the distinction between real bull markets and fake ones. It concludes that the recent market advance is not the real thing. It is up to investors to decide their conviction level, pain threshold and then pray for luck with their timing if they decide to act on the view that the world economy had not healed enough to warrant the level of optimism implied by the recent gains in stock markets globally.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org