Saturday, 14 April 2012

Irrational markets article (daily mail).

I hadn't just cottoned on to the fact that today (now yesterday!) was Friday the 13th until I read the following amusing, and disconcerting, article:- Friday 13th - and 13 reasons why today's markets are irrational.

Taken directly from the Daily Mail article:

"The 13 'unnatural events' that sum up today's bizarre markets:
1. The financial situation of many developed economy governments has never been worse ... yet the rates at which they can borrow money have never been lower. The US has 3.3 times more debt outstanding than a decade ago and yet the yield demanded by the market has fallen from 6.1 per cent to 2.0 per cent
2. Investors are lapping up corporate bonds (P&G 10 year at 2.3 per cent and McDonalds 30 year at 3.7 per cent) whilst selling the same companies equity where the well covered equity dividend yield is higher than the corporate bond yield.
3. Bond yields are below 2 per cent indicating that there is a very low probability of inflation and a high probability we are turning Japanese. Meanwhile, gold races onwards and upwards as central bank money printing points to a probability of inflation.
4. Bond yields are at all time lows, and no one wants to borrow money even at this rate... but central banks keep spending billions to try to get rates down just a little bit more.
5. Some of the smartest investors in the world (Warren Buffett, Seth Klarman, Jeremy Grantham) think bonds are hideously over valued and yet most pension funds are looking to increase their allocations to bonds and bond funds continue to top the best selling fund tables.
6. Corporate earnings are at their all time highs, are strongly mean reverting and in the long run grow at about 5 per cent nominal… so of course for this year, the sell side forecasts 10 per cent growth and fund managers and strategists continue to talk about how cheap equities look on one year forward P/E’s.
7. The average holding period for UK equity has fallen from 10 years in the 1950’s to 22 SECONDS!! Note to David Cameron, if you are expecting shareholders to exert greater influence on management remuneration, owning a stock for 22 seconds makes attending the AGM quite tricky.
8. The ECB, backed by European sovereign states, is lending money to European banks at 1 per cent so that the European banks can lend money to sovereigns by buying government bonds of European states or put it back on deposit with the ECB. Everyone seems to think this is great but when Bernie Madoff did it he was arrested.
9. Articles about how hedge funds swallow up 85 per cent of their client’s investment gains in fees continue to appear alongside articles about investors’ intentions to increase exposure to hedge funds.
10. During the credit crisis the ratings agencies rated over 50,000 subprime CDO’s as AAA….and yet the markets still hang on their every word.
11. Luxury goods used to be the first thing to go in an economic decline whilst basics would hold up. But now we have Tesco posting their worst sales for 20 years whilst Burberry grow sales at 20 per cent and new orders of Bentleys are up 50 per cent.
12. The vast majority of economists and strategists have proved hopeless at forecasting anything…. And yet continue to be hugely over confident in their ability to predict the future. “A Chinese hard landing is as likely as a comet destroying the earth.” - Jerome Booth, Daily Telegraph 19th February 2012.
13. Most investors would choose pile A (enough gold to fill the infield of a baseball pitch) in this year’s letter from Warren Buffett over pile B (which includes: a) all the farmland in America with output of $200billion annually AND b) 16 Exxon Mobils generating $640billion annually AND c) $1trillion of cash) because ‘gold is the only true store of wealth’. "

The clearest theme appears to be a confusing contradiction which illustrates the push me pull you direction prevalent in global markets.
But I especially like the last point which further suggests to me "how to think like a rich man?"; and that personal discipline, recognising your personal investment horizons, and being realistic about your goals are absolutely fundamental.
It also won't be easy to achieve them with various sources seeking to draw you from your path by feeding both the extremes of your fears and hopes for the future.

Some of the points have fueled my concerns about the integrity of any recovery, inflationary risk (in bonds, commodities, prices etc), and any negative longer term effect that cheap credit might yet fuel again without a clear cultural and behavioural change.

The dependency being placed on China to rescue the world is also concerning given that it has traditionally been the beneficiary of growth (on the supply side) but is now being seen as a growth driver for commodities, and a fast expanding frontier for growth for all Western consumer brands.
Inevitably some will succeed and many will fail.

As for the ratings agencies, they do also seem to be out of touch and must surely find a way to be much more transparent about their methods and computations to re-establish credibility.

Just stating the bleeding obvious and saying that a country or company is going to be downgraded because of "market sentiment" (Contagion Flu! ) as the right words haven't been spoken by politicians is no use to anyone and does little more than appease the majority with what they want to hear.
Particularly given their inability to remotely recognize the multiplying effect of debt risk in the run up to the credit crunch which opens them up to the criticism of failing to substantiate and doing little more than telling the majority what they wanted to hear i.e. that they were all onto a good thing.

However, a scenario stress test (with understandable but unpalatable variables), of a company's balance sheet or cash flow projections at least gives a view on what or how circumstances might cumulatively weaken a company's finances to reach a sufficiently concerning conclusion.
How else could they be substantiating their views and ratings?

The article also serves to downplay my constant fear that someone always knows more than me as the points made serve to illustrate that there are always at least 2 sides to any point.

All food for thought!

Article link:
- Friday 13th - and 13 reasons why today's markets are irrational.

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