This will be my last column in this space for a while, as I am taking time off from regular back page writing in order to take up, for a stint, the cause of long term investors in the institutional market. Although I will continue to offer periodic thoughts on the state of the markets on my website, where you can find more details, and an archive of my past columns, it seems like a good opportunity to award some informal gongs to those whose thoughts or actions have most impressed me over the course of the past three years writing for the FT.
As I see it, we have arrived at the start of 2011 in one of those always interesting periods when the interests of long and short term investors are once again in conflict. The chances are that performance chasers may well continue to benefit from a continuation of the strong recovery in risk assets that characterised the latter half of 2010. From a longer term perspective, however, there is very little that looks obviously cheap (Japan being one exception). Ten-year returns from equities as a class from today’s levels will most likely be indifferent. This is pretty much what you would expect 22 months on from the start of a new equity bull market, and in a world where central banker are moving heaven and earth to keep normal economic reality at bay through interest rate and market manipulation.
Most investors, as I see it, remain fearful, and temperamentally reluctant to commit money to risk assets, but the consensus on the sell side is frighteningly bullish, which is clearly a cause for concern to any self-respecting contrarian. Many of the markets that have boomed in the second half of 2010 – including equities and commodities – are heavily overbought, so a correction is inevitable. The AAII adviser sentiment indicator, for example, is at its highest level since earlier market peaks, which strongly suggests the need for caution.
Nevertheless negative real interest rates are gradually having their intended effect and there are some signs in fund flow data that some of those who fled to bonds in the aftermath of the crisis are having second thoughts and some are coming back towards riskier assets. However it is also clear that many advisers who profess to be bullish are failing to convince their clients to act as they say they have been suggesting, so the scope for a further leg to the bull market is still there.
In the short term, US and some other Government bonds may offer temporary value after the H2 rise in yields, but the longer term trend in yields is definitively upwards, and I would wager will happen at a pace which is faster than many market participants currently – and I would say, complacently – expect. Set against that must be the force of a concerted monetary push from authorities in three different currency zones – dollar, euro and yen – to keep the prices of most assets as high as possible. Currency debasement by indebted countries remains the order of the day and inflation is the inevitable destination.
Who then has stood out over the last three years as beacons of sound advice in some very difficult market conditions? My first award goes to the evergreen Barton Biggs, a brilliant chronicler of hedge fund experience, who correctly foresaw in October 2008, only slightly too early, the onset of “the mother of all bear market rallies”. That was one to remember and file away, as was Anthony Bolton’s perfectly timed call of a new bull market a few months later. Annoyingly for those who think that stockpickers should keep out of the market timing business, reality has played out just as the Fidelity money manager predicted at the time.
An award too goes to the colleagues of the late Nils Taube, who gave me unprompted a pitch-perfect call in March 2009 to suggest that the long 2007-09 bear market had finally turned in the UK. A special mention too goes to Jack Bogle, the founder of Vanguard, who remains well into his eighties a beacon of moral fervour in a business which all too often tends to conflate virtue and self-interest (as represented, all too often, by higher fees).
An honourable mention also for Jim Grant, the editor of Grant’s Interest Rate Observer, who showcased research at the height of double dippism in 2009 that said a normal V-shaped recovery in growth (though not unemployment) was the most likely outcome for both the US and world economies, something which I think will be confirmed by the final historical record when it eventually appears. This comment from the late J.K.Galbraith, he of the killer phrase, seems apposite too: “Historians rejoice in crucifying the false prophets of the millennium” he wrote. “They never dwell on the mistake of the man who wrongly predicts Armageddon”.
It is of course too early to say with certainty that financial Armageddon has been avoided. A new banking crisis in Europe remains a disturbing possibility. The bill for imprudent property lending remains to be settled in many countries. Policy errors are only a summit meeting away. Many structural problems in banking persist. Competitive currency debasement cannot be sustained indefinitely. Higher bond yields are on the way. And so on. It is always possible to list a myriad of concerns at any one point in the market cycle. That is partly the fun of the game. For what it is worth however, I sense that we are through the worst, but not yet out of the woods, notwithstanding that a correction must be coming soon in some overbought asset classes.
Jonathan Davis 