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Archive for the ‘Forecasts’ Category

Hoping for the best in 2011

The strategy team at Societe Generale, regularly ranked the best in the City, despite their idiosyncratic ways, chose a useful title for their annual presentation last week on the outlook for markets in the year ahead.  Hoping For The Best, Preparing For The Worst neatly summarises the bipolar nature of where I think we are in the cycle – not much to play for in terms of long term returns, but nevertheless some good reasons to think that the current market recovery can continue into 2011.

Here are a couple of keynote charts from their presentation.  One shows where the US market sits on two well-known long term valuation metrics, a cyclically-adjusted p/e ratio (named after Prof Robert Shiller, the US academic who popularised the methodology) and Tobin’s q, which measures the ratio between the current value of the equity market and the replacement cost of its component companies’ assets.

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Written by Jonathan Davis

January 24, 2011 at 11:40 AM

Put Not Your Trust in Forecasts

Never invest on the basis of forecasts. So says James Montier, recently anointed the dean of behavioural finance in the UK. Glance at the index of Value Investing, his superb collection of essays on the subject, and you will find that “forecast” appears more often than any other, with the exception only of the holy of holies, Ben Graham himself. References to the former are as consistently negative as those to the latter are positive.

“The evidence on the folly of forecasting is overwhelming” Montier concludes, whether you are talking about economists or stockbroking analysts. “Frankly the three blind mice have more credibility than any macro-forecaster at seeing what is coming” is his verdict on economists. As for analysts, he notes that the average forecasting error in the US analyst community between 2001 and 2006 was 47% over 12 months and 93% over 24 months.

And what does Ben Graham say? Simply this: “Forecasting security prices in not properly a part of security analysis”. Judging by the response to my last column, which described John Templeton’s approach to the forecasting business, this is a view that many participants in the securities business share. The only professionally acceptable response to any question on the subject of analyst reports is to say “Well, I read them – but only for the data, you understand, not for the recommendations”.

The only problem with all this is that it doesn’t seem to be true. It would be nice to meet a few professional investors who don’t in practice, either implicitly or explicitly, rely quite heavily on forecasts to inform and justify their investment views. This has prompted me over the years to formulate some other rules which I have found helpful in distinguishing between useful and useless research.

The first of these is this: “Don’t rely on what anyone says they are doing. Look at what they are actually doing”. Just as comment is free, but facts are sacred, so too market punditry is cheap, but actual investment decisions are the only thing that really matter. I recall a meeting of IFAs in March 2003 at which, on a show of hands, a clear majority of those present disputed a claim by Anthony Bolton that his then public bullishness on equities was a contrarian call.

A second show of hands then revealed that, although being bullish was what the majority professed to believe, only a tiny minority of those present had actually positioned their clients’ portfolios to reflect that view. While the audience was talking about loading up on equities, Bolton was one of the few who had already done so. A year later many in the audience were still struggling to catch up with the renewed bull market that they had called, but signally failed to act on.

A second valuable rule is “Never waste any time on investors who appear to be telling the markets what to do”. Saying something will happen is a good way to generate a headline, but a poor way to make money. Every investment call can at best be an assessment of probabilities. Those who proclaim that an outcome is a virtual certainty are either deluded (if they believe their own pronouncements), charlatans (if they don’t believe it, but go ahead and make it anyway) or professionals who are paid to believe it (brokers and headline writers being good examples). Those who are hesitant and make liberal use of phrases such as “my guess”, “the most probable outcome” and so on are the ones talking the true language of the market.

A third useful empirical rule is “Don’t use Japanese experience as proof of anything”. Many of us have fallen at this hurdle over the years. Just as the great equity bull market of the 1970s and 1980s powered on beyond any possible rationalisation, so too the subsequent 20-year period has been full of commensurate disappointments.

The Japanese economic experience of the last 40 years serves only to demonstrate that Japan, for reasons that are open to analysis, marches to different rules from almost every other market, society and economy. It is the exception to almost every rule in the book. Those who currently claim that the US must inevitably follow Japan into 20 years of debt deflation are breaking both the second and the third rule.

If forecasts are no use, then what is the basis on which investors can or should make decisions? Value has to be part of it. Momentum is also a useful tool: wonderfully consistent as long as it works and then periodically catastrophic when, as invariably it does, it breaks down. Technical analysis, if used as a guide to probabilities, has a place; ditto good fortune. A good deal of the time however, including most likely the present, markets can appear to be neither obviously dear nor cheap. Who, though, one wonders, is buying Government bonds today out of unalloyed conviction?

Written by Jonathan Davis

January 22, 2010 at 6:27 PM

Double Digit Real Returns On Offer?

The latest quarterly asset class return forecast from Jeremy Grantham’s Boston-based fund management group GMO makes for interesting reading. For the first time in a long time, the seven year forecast envisages that equities will produce annualised real returns that are above their long term average. In the case of high quality stocks (those with strong balance sheets, positive cash flow and so on), GMO is projecting real returns of 11.4% per annum. For US stocks in general the figure is 7.4% and for emerging market equities 10.7%.

Since GMO is a value investor, it is no surprise to see that it sees little or no value in Government bonds at today’s very low yields. In fact it expects US Treasuries to produce negative returns over the next seven years. It is more positive on emerging market bonds, which it sees making a 4.5% real return over its seven-year forecast horizon.

Although he has been widely dismissed as a perma-bear, that is, someone who is always negative on the outlook for stocks, to my knowledge Jeremy Grantham is a more complex prognosticator than that description would suggest. His warnings that stocks were overvalued during the Greenspan bubble years, and that investors were becoming myopic about risk, have proved to be amply borne out. But in his last quarterly letter (strongly recommended for those who do not know it) he takes a very different stance. The greater risk facing most investors, in his view, is that they will miss out on the market recovery when it comes.

At the same time however, historical analysis tells him that most bull markets over-correct on the downside before they are done. So while stocks are now back to somewhat better than fair value, in the short term they could get worse before they get better. Grantham says his worry is that he will get back in too early, as he has done many times before. This seems to me a good summary of where we stand today. Equities have certainly started to look good long term value, and comfort lies in the fact that, while it is possible they could fall another 20%-30% from here, those losses will be recoverable quickly whereas the 30%-50% losses experienced from extreme 2007 levels might not be recouped for many many years. Investors will need to be selective however.

Written by Jonathan Davis

January 2, 2009 at 1:00 AM

Posted in Forecasts