On equities and all the returns in your egg-adjusted basket
It is barely two weeks since the papers and the wires were full of the happy news that the S&P had eradicated all the post-crisis losses and that it was now making new highs again. Having worked on principal protection structures, I knew that looking at indices on headline number only is a mugs game.
Without name-dropping – a favoured sport of columnists – I called in on a chum from the financial TV world and asked why the issue was not being raised. Apparently it had been but the equity tribe was happy to counter that dividends covered that space and that was it. I was left scratching my head.
Then, up pops David Rosenberg, chief economist at Canadian wealth manager Gluskin Sheff but surely remembered by many as chief North American economist for Merrill Lynch when it was still the old thundering herd. Rosenberg is quoted in Business Insider for a study he has done and in which he – maybe related to Easter – values the S&P against the price of eggs.
He begins by quoting Kyle Bass who said “one of the best performing equity markets in the last decades has been Zimbabwe. But now your entire equity portfolio [in Zimbabwe] only buys you three eggs”.
He then goes on with his own study:
“While there has been a market recovery, it is far more subdued on this basis… in egg-adjusted terms, the S&P 500 is more than 20% below its pre-recession highs and about half what it was at the all-time highs 16 years ago. In milk terms, the S&P 500 is actually 15% below its its pre-recession highs, and in bread terms, the index is 10% lower. Just in case you thought I was cherry picking what’s on the breakfast table.”
Whether unwittingly or not, Rosenberg raises a huge issue when it comes to measuring real returns, namely that each and every item has its own idiosyncratic inflation rate and that none of these equate particularly to reported inflation. That is, I suppose, unless an individual consumes the exact basket of goods which would probably demand that each month we consume a dozen eggs, four cans of corned beef, a packet of Prozac and an iPad… or at least something to that effect.
When the drain comes
Rosenberg then goes a stage further in valuing stock markets and charts the relationship between the market cap of the S&P and the size of the Fed’s balance sheet. We all “know” that equity prices are driven by QE but I have, as yet, not seen any significant research which equates one to the other and which therefore would draw conclusions as to what happens to equities if, as and when the Fed begins draining liquidity again.
Even at the best of times, stock valuation is more of an art than a science – Keynes observed that the way to make money in the stock market is not to select stocks which are cheap but to identify ones which are going to prove to be popular. I was led to smile wryly when I heard a seasoned investor last week explain that he had been brought up to value on a discounted cash-flow basis but that, with rates at zero, he suddenly found himself high and dry.
The latest irrefutable wisdom is to be long the Nikkei and JGBs, hedged back into US dollars but even that is becoming a crowded trade although I take my hat off to those hedgies which put it on immediately after it became clear that Shinzo Abe was heading for the top. Although this is one of the few significant long trades of the past twelve months which has had proper fundamental backing, I’d bet that many, many investors missed it because it was “not in the benchmark” or would have blown tracking error limits.
Remember that in the world of CFAs outperforming the benchmark by too much is an equally terrible offence because it apparently displays reckless risk taking.
I was talking to a US money manager yesterday who was bemoaning the fact that fifteen years of experience are now for nothing as markets run up and equally run down again without substantive reason and that, although one can trade them quite nicely, it is impossible to formulate a sensible medium term view. By the time a strategy paper is researched, compiled and submitted, it is out of date again.
Meanwhile, more topically, China was downgraded by Fitch last night. It might not be a nice thing to say but I found nobody who really cared.
Apart from that, the yuan was today fixed by the PBC at 6.2548/$, a 19-year high. Put that in you pipe and smoke it.