Love it or hate it, Goldman has in the past often been the house that has come up with the one observation that has changed what markets think.
I personally recall Goldman pronouncing that US money supply was no longer the most important release on the slate and that it was the non-farm payroll number that we should be looking at when trying to divine future monetary policy. I also remember Goldman telling us in March 2009 that, from an investor’s perspective, the crisis was over and that it was time to get seriously long of equities again. On March 9 2009 the Dow stood at 6,547.05. Last night it closed at a new all-time high of 21,528.99. That marks a rise of 228.83% or an annualised return of 15.45%.
Markets keep going up. The Dow keeps setting record levels and so does the S&P 500. The FTSE 100, despite all the Brexit news is within just 24 points of its own high. The Nikkei needs less than another 600 points to sweep away the June 2015 high and to set a new record for the century. Meanwhile the Dax closed at a record last night and I could go on. And yet, every day there are endless conversations between market professionals perplexed by the rock-hard resilience of asset prices to any rational argument that they are overpriced and in bubble territory. To repeat a recent observation, Wall Street is littered with the corpses of those who thought it was time to go short.
So is the market wrong or are we all missing some paradigm shift which has surreptitiously taken place that we lack the necessary sensors to pick up on? Well, if anybody is going to tell us, it has to be Goldman Sachs; if it were to be me or one of my fellow teenage scribblers who were to have drunk from the fountain of wisdom, nobody would listen.
The simple fact is that Wall Street has become aimless and none of the conventional econometric yardsticks deliver the basis for this ongoing rally in risk assets.
WEIGHTING GAME
I have long argued that the only meaningful explanation for the unrelenting increase in equity prices and the concomitant compression of credit spreads is to be found in the unfavourable differential between interest rates and dividend yields.
To put it simply, the FTSE’s three largest stocks by weighting are HSBC, BAT and Royal Dutch Shell at 7.27%, 5.40% and 5.00%, respectively. HSBC, with a beta of 1.11 delivers a gross yield of 5.83%. For BAT the same metrics read 1.00 and 3.04% and for Shell they are 1.23% and 6.96%. Then all one needs to do is to lay up the yield on Gilts, which for the benchmark 10-year is 1.03% which falls to 0.47% in the five-year space and to 0.165% for the two-year maturity. All the answers are there but Wall Street is micro-analysing statistical releases and can’t understand why the economy and asset markets aren’t communicating.
Investment banks, still the prime suppliers of research, generally have a problem understanding how investing works. Traders are obsessed with, no surprise, trading profits or, in other words, capital gains. The days are over when they ran huge carry books that often rivalled in size the investment portfolios of their clients. Income streams mean nothing to them. To institutional investors, who have pensioners, widows and orphans to feed, the world looks very different and constantly having to liquidate positions, even profitable ones, in order to meet the liabilities benefits nobody other than they guys who gets to keep the bid/ask spread. Realising capital gains therefore costs money that collecting dividends or clipping coupons, in as much as there is anything worth clipping in the latter, doesn’t.
The sad fact now is that until Goldman Sachs publishes a paper on this phenomenon and tells the world that the simple differential between dividend yields and interest rates is the only thing to watch, nobody will care and confusion will persist as to why risk asset prices so doggedly refuse to go down.
That would help to explain why it has been impossible to align the direction of energy prices and other commodities with the performance of overall stock markets. There was a time when, if oil went up and with it the value of energy stocks, everything else went down. The past two years with all the extraordinary swings in the price of hydrocarbons has not been reflected in any discernible and correlated trading patterns in the main markets. Sure, post factum there is always a way of linking a move in this direction here to another move in a different direction there but predicting moves in B contingent to certain moves in A simply doesn’t work anymore.
Though brief, I hope I have explained why once again at the end of Monday’s column I suggested nothing other than “stay long”.
CHARGING AHEAD
Meanwhile the former CEO of Barclays John Varley and three others, including the former head of the Middle East investment banking business, are to be charged with fraud over the back-room recapitalisation of the bank during the 2008 crisis. I don’t know the details but unconventional times sometime demand unconventional measures. I suppose letting the bank fail on the basis that the money markets were no longer working and becoming another Royal Bank of Scotland or Lloyds might have been the only alternative. This country has a long history of loving “have-a-go heroes” who tackle crooks rather than waiting for trained police officers to arrive with their ability to assess risks and manage such situations. I don’t have the evidence although I remember the period well and as far as my memory tells me Varley and his merry men “had a go” themselves in order to keep the bank solvent.
It is understandable that Varley didn’t have to time to go to the FCA, the board and the shareholders when preventing Barclays from sinking into the swamp. It might be that there were corners cut and procedures missed but the bank survived without shareholders being wiped out. They might have been severely diluted but sometimes needs must.
I ought not to prejudge but my instinct tells me that Varley deserves a medal and not a fraud charge. Next the stealth and hasty brigade will be posthumously charging Winston Churchill with smoking and drinking in the workplace.