My Comments: I’m trying very hard to avoid “irrational pessimism”, the polar opposite of “irrational exuberance”. But at my age, if things go downhill in a hurry, I’m going to be toast.
Many of my clients over the years had parents that grew up in a family that was killed economically in the Great Depression and the follow up suffering rewired their brains. This caused their children, my clients, to have what is/was in my opinion, a bias that prevented them from taking normal risks and allowing them to grow their money intelligently.
The other day I had sort of an epiphany in that I realized perhaps my brain had become rewired as a result of what happened in 2008-2009. And that I’m projecting a bias that is not helpful to my clients and friends who depend on me to help them make intelligent guesses about how to invest their money going forward.
Be that as it may, I’m still pessimistic about the near term future and this article does nothing to suggest my brain is totally out of whack.
Laura Suter | 8 October 2016
The FTSE 100 soared to near record highs this week, but as the blue-chip index rose so did investors’ fears that the market was overvalued and primed to crash.
Last year the index passed the levels seen in the dotcom bubble, when it hit 6,930 in December 1999. But the heights reached this week prompted warnings of a return to the “irrational exuberance” of markets in the Nineties.
Some share prices have shown eye-watering growth since the low of February this year. Shares in the mining giant Anglo American have risen by 215pc, while rival Glencore has gained 148pc.
Looking at the measure of company share prices relative to their earnings, a popular valuation yardstick, the London market does look expensive.
The headline price to earnings ratio, based on profits over the past 12 months, shows that the market is now trading at 19.2 times earnings.
This is still below the 26.7 times seen at the height of the dotcom bubble in December 1999. However, it is significantly above the average of 14.1 times.
Investment guru Jack Bogle, founder of Vanguard, the low-cost asset manager, has warned that returns are falling.
Talking to Morningstar, the investment analyst, this week, he warned that dividend yields on US shares had dropped to 2pc, down from their long-term average of 3.5pc.
What’s more, Mr Bogle warned that over the decade returns on the stock market would be around 4pc, before inflation. After estimates of 1.5pc to 2pc for inflation, that means stock markets will generate a 2pc 2.5pc real return. This is far below long-term averages.
While the FTSE 100’s dividend yield is substantially higher, the fortunes of our stock market tend to move broadly in line with Wall Street, implying leaner times ahead for British investors too.
Adding to Britain’s woes is that the International Monetary Fund now believes the country will grow at a slower rate. The IMF slashed its prediction for UK economic growth for next year to 1.1pc, down from 1.8pc this year.
Investors have been urged to sell British shares and reinvest the proceeds in other assets, a process called “rebalancing”.
However, there is another view.
Some believe that the simple ratio of price to earnings (p/e) is not a good predictor of returns or market highs. Company earnings are volatile and hard to predict, and at times of crisis the p/e ratio does not show a company’s potential, say critics.
This is why the “cyclically adjusted p/e” or “Cape” measure was developed by the acclaimed economist Professor Robert Shiller. This uses the average of earnings for the past 10 years, adjusted for inflation. A low Cape measure can be an indication to buy a stock.
On the Cape measure the UK market is undervalued relative to historical levels. The UK stock market’s Cape ratio is currently 15.6, compared with 32.3 in December 1999. It is also below the long-term average for the market, of 19.4 times.
Mr Shiller agrees with this analysis. He said last week that Brexit would not be “as bad as everyone fears” and that he “should have allocated more UK shares to his portfolio”.
Star Capital, an investment manager based in Europe, also agrees with this valuation. It said its analysis showed that the UK stock market had a lot more room left to grow. Based on current valuations, it predicted that over the next 10-15 years UK shares would deliver 7.8pc annual growth.
Company prices today are nowhere near the unrealistic valuations of the dotcom bubble, said Ben Yearsley, a founder of Wealth Club, an investment service.
“In the dotcom bubble certain telecom, media and technology stocks were just wildly overvalued. They went from £1 to £10 to £30 almost overnight. If you look at the FTSE today as compared to 1999 or 2000, it might be up but there are not sectors that you look to as being bonkers,” he said.
However, one concern is how closely the FTSE’s fortunes are linked to sterling’s movement. The pound has dropped by around 15pc since the EU vote, and the market has gone up about the same amount.
“Certainly there has been correlation over the summer between sterling falls and the stock market rise, and I can see that happening for a while longer while we are in the pre-Brexit stage. If sterling falls by another 10pc you will probably see another rise in the FTSE,” said Mr Yearsley.
Laith Khalaf, senior analyst at Hargreaves Lansdown, the fund shop, said investors’ nervousness was a good sign that markets hadn’t yet reached their peak.
“People are cautious about the market, no one is gung-ho. There is about £160bn in cash accounts paying zero interest. People are wary of the market,” he said.
“When you are in the pub and everyone is excited about markets and giving share tips, that’s the time to get nervous. I don’t think we’re anywhere near that.”