Those of us who have been following the work of the independent market analyst Andrew Smithers for many years (and my experience goes back more than a decade) never thought we might live to see this day. But here it is – an unambiguous statement that the world’s equity markets may now be the right side of fair value. This is the first time such a view has emerged from Andrew’s one-man think tank since I cannot remember when, although he still qualifies it by saying he thinks the likely trend in 2009 is still down (value in stock markets being no guide to short term price movements).
The great thing about all Andrew’s work is that while he has firm opinions, he has no obvious axe or vested interest to grind. Having made enough money form his years in fund management at Mercury Asset Management (in its glory days), his consultancy work today is driven as much by intellectual curiosity as by the tiresome business of giving fee-paying clients what they want to hear.
Here is an extract from his latest report, which assesses how markets stand today on the basis of what he likes to call “hindisght value”, the methodology he and the Cambridge economist Stephen Wright in their pioneering book Valuing Wall Street, published just as the Internet bubble was peaking.
• We have just published a report on world market values.1 We conclude: (i) that the world market in aggregate, at the end of January, was around 38% below fair value, (ii) that the US is relatively expensive, being around fair value and (iii) that Japan is the cheapest market.
• While value is of little use in forecasting short-term market movements, our conclusions are encouraging, because in bad times, and these are bad times, markets usually become decidedly cheap.
• We remain bearish about the outlook for equities for 2009, mainly because we see the demand for shares by companies falling and their supply rising as both financial and non-financial companies change from buying shares to issuing them.
• Government bonds are expensive, though likely to remain so for a while as the world economy continues to weaken. But the short-term outlook for corporate bonds seems quite good. Their yields are determined by three main factors: (i) Government bond yields, which we expect to be flat short-term and to rise in the medium-term, (ii) the compensation for buying illiquid assets, which we expect to fall as governments and central banks push liquidity into markets and (iii) default risks, including downgrades and recovery rates, which are unknown but, we fear, still underestimated in many instances. We are optimistic that the good point (ii) will dominate over the next few months
• The refinancing of the banks, which is a necessary condition for economic recovery, is meeting opposition from voters, who think it gives unfair help to bankers and from bankers, who strive to avoid asset write-offs.
• Fiscal stimulus is another necessary condition for economic recovery, and this is meeting opposition from various sources, including those who reject or don’t understand Keynes’s theories. These groups tend to think that fiscal deficits increase total debt, rather than shift it from the private to the public sector. We expect both banks and fiscal problems to be overcome in time, but in neither case, on a worldwide basis, are sufficient steps likely to be taken quickly.
My only comment on this is that a big bounce in the stock market during 2009 is not incompatible with this view. Smithers’ research centres on the long term relationship between value and price, which can be empirically assessed, rather than on short term market dynamics, which by and large can not.