Sometimes things are obvious. That was true in late February when an overpriced market hit a seemingly terrifying virus. The market started to crash. I wrote that you would be mad to buy the dip. It was true again in early March. Things were beginning to look too cheap, virus or no virus. Start thinking about what to buy, I said.
Then came the end of March, the point when you really needed to be buying. I wasn’t sure that you should go all in (most bear markets test their lows a few times). But most markets were at 20-year lows in terms of their Shiller cyclically adjusted price/earnings (Cape) ratio, one of the better indicators of long-term value. On a decade view, 90% of markets were showing negative returns.
It’s time to buy, I said — and in particular to buy the likes of Facebook, Amazon, Netflix and Google. For years they had been too expensive for me to feel safe suggesting you go all in. But in March they seemed to be not only less expensive but also providing the few services we both really needed and could still access. There was no price not worth paying for that!
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So here we are, nine months on. Somewhat miraculously, my March buy-now-for-the-long-term column came a mere three days after global markets bottomed (over 30% down), something I hope will go some way to making up for some of my less well-timed calls over the past few years. The S&P 500 is up 65% since; the FTSE 100 is up 31%; Amazon is up 92%. Anyone who held their nerve and sold nothing in to the crash would have been evens within five months.
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Things look expensive, but everyone is bullish
What next? Everything seems to move so fast these days — note that the average recovery time for global markets after a fall of this magnitude is 29 months, say the analysts at Schroders. Has the long term already come? Look at valuations and you might think so. The global stockmarket is now 8% above its pre-Covid panic peak. Global stocks are 45% more expensive than their 15-year average in price/sales terms. The US market is on a forward price/earnings (PE) ratio of 23 times, just as it was in 1999, and most tellingly of all the Shiller Cape has just exceeded its October 1929 peak. Its current level of nearly 32 times has only ever been exceeded before at the height of the dotcom bubble, says Albert Edwards of Société Générale. Add it all up and “US equities have never been as expensive as they are right now”. Yikes.
Yet despite all this scarily compelling data, pretty much everyone is bullish. At a recent Pictet Asset Management webinar, 81% of those asked in an online poll said they expected equities to be the best performing asset class of 2021. Fund managers are mostly very bullish — a recent survey suggests their cash levels are down to 4% (this is the kind of number that usually suggests they are a bit too enthusiastic). They are still overweight the US and technology, but also busily saying they are buying into the reflation trade — banks, commodities and anything consumer focused. They are, they say, all in.
And Robert Shiller, the man behind the Shiller Cape? He doesn’t believe the message his own measure is sending us anymore either. The blip in March aside, the Cape has now been so high for so long (this isn’t supposed to happen) that he has had another look at it. He has produced a new measure — the Excess Cape Yield or ECY — which attempts to adjust for today’s super-low interest rates. The point here is simple: the lower interest rates are and hence the less we can get for our cash, the more highly we will value income streams from other sources. Look at it like this and — ta-da! — US stocks aren’t actually expensive but perfectly reasonably valued. The ECY is 4%, a level from which stocks have returned an average of 5% a year in real terms for a decade. I think we’d all be happy with that.
Markets are looking ahead to a surge in demand – and inflation
Edwards is not convinced. He likes to remind us all that in early October 1929, Yale economist Irving Fisher announced that to his mind, “stock prices have reached a permanently high plateau”. Is Shiller the new Irving? Our very own canary in a stunningly overpriced coal mine? Maybe. Maybe not. The first thing to remember is that markets don’t price the present, they price the future. And next year looks nothing like the kind of years that usually follow severe recessions. The Covid problem should be all but gone by the end of the first half of 2021. Remember that once you have vaccinated the over-75s you’ve removed nearly all the mortality risk.
Personal and corporate balance sheets are much healthier than in any normal recession. Anyone thinking about the health of global demand should keep this fact at the front of their mind: this year central banks globally have printed $8tn — that’s close to 10% of global GDP. There is not usually a hugely strong demand recovery a matter of months after GDP drops by double digits. This time there is. Next year corporate earnings will soar — and P/E ratios will fall accordingly.
The second point is that we may be about to enter a new age of surprise inflation as demand rises and supply struggles. Analysts at Gavekal Research point out that Chinese factories are already “struggling” to keep pace with US demand. If so, and assuming interest rates stay low, what are the choices for investors who want to maintain the real value of their wealth? A large part of the answer to that has to be equities.
There is risk aplenty here — in the vaccine, in government and central bank policy error and in consumer behaviour. We are no longer in a world in which you can buy anything and wait to be rich. So while you should stay in the market, you also need to cut your risks by pivoting your portfolio from expensive stuff that has benefited from Covid-19 to cheaper stuff that will benefit from the end of Covid. That’s the UK (the only cheap market left); Japan (which tends to perk up as the global economy does); and possibly China and emerging markets. None of this has the glorious absoluteness of markets in February and March. But that ambivalence does at least represent something of a return to normality.
• This article was first published in the Financial Times
