August 11, 2002

Herd instinct will save stockmarket

Posted in ·
Share 

China will have the greyest population in the world, the population of Argentina will be five times greater than that of Germany, while eastern Europe will be entirely denuded of Slavs.

Playing silly games with present population trends can lead to seemingly odd predictions. Yet nothing will determine the future of the globe and its wealth in the next 20 — let alone 200 — years as much as population patterns.

Of course, extrapolating from today’s trends is no guarantee of accuracy and it is likely that at some stage the Japanese will start having more babies rather than disappear.

Yet there is no getting away from the fact that the size and age of the population is crucial for the wellbeing of the nation.

Population is critical because it affects savings. When you are a youngfella there’s no need for saving. It’s all spend, spend, spend. As you move into your 30s this gets even more pronounced.

Spending and borrowings peak as mortgages are taken out. In our 40s and 50s we begin to save properly, our incomes go up and many begin to see financial light at the end of the tunnel. Finally, into our 60s and beyond, we become — to use that priceless phrase — ‘heavy savers’.

Countries share characteristics with individuals. Old countries save more and grow less quickly. This manifests itself economically in current account surpluses, which are evident in Japan and the European Union.

In contrast, developing countries in Latin America, Africa and the Middle East have huge deficits because the young populations are spending and neither earning nor saving. The US is an anomaly, as one of the reasons for its dynamism is the structure of its population, which is still both relatively young and, due to immigration, growing.

Therefore, the global system works because the old countries in the world lend to the younger countries. Sometimes the younger countries borrow a bit too much, which can lead to financial crises such as the one Brazil is having at the moment. Equally, old countries can sometimes save too much, leading to growth crisis and rising unemployment, as evident in Japan and Germany today.

The point is that the global financial market, when reduced to its simplest form, is just a worldwide mechanism for distributing savings — both among countries and within countries among generations.

We can argue until the cows come home about whether the mechanism is flawed or not, but the basic point remains.

For example, the bailout of Brazil last week suggests that there are serious problems with the way in which savings are allocated around the world, but the fundamental conclusion is that the financial markets take money from savers and give it to spenders.

The savers hope the spenders will generate more revenue and return interest back. Sometimes this happens and everyone is happy, and sometimes the spenders blow the cash on the economic equivalent of sex, drugs and rock ‘n’ roll and it all ends in tears.

The fallout of the great stock market boom and bust of the past five years poses serious questions for the choice of savings vehicle in the future, mainly because people who have been burned are no longer interested in jam tomorrow.

Listening to some of the great and good from the stockbroking world on the airwaves or in the many investment newsletters doing the rounds, we could be excused for believing that the stock market will rebound.

If this were true, all the products on offer from the banks and building societies should be snapped up today.

You should drop this article right away and go out and buy the tracker bonds, low risk equity funds and protected funds or whatever is advertised in this paper and others.

But how can you trust the blokes who believed the Dow Jones was a buy at 10,500 or had buy recommendations on 90 per cent of the stocks they covered at the start of the year? You can’t!

Worse still, it is now rational to conclude that the people selling any of these pension products haven’t the faintest idea what they are talking about — which is scary.

If the stockmarket and these linked pension products are to keep us in clover in our retirement, savers will have to revert to the same herd behaviour that dominated in the boom/bust cycle.

In the future, savers will still have to be prepared to forego cash today for the promise of capital gain tomorrow.

Now, unless you were one of the lucky ones who has the knack and identified a bubble back two or three years ago, this approach to savings going forward will make you so poor you’ll be flipping burgers in McDonald’s into your 70s.

The jam tomorrow school of savings is over. These days, for people to come back into the stock market and buy shares, companies have to offer some concrete cash incentive.

Only the foolish should be satisfied with the jam tomorrow prospect of capital gain because it depends on the herd returning to the market and the herd will not return until some other sweetener is offered.

Once the herd is back, playing the market is all about timing, luck and being just one move ahead of the posse — but that day is still a long way off.

So what will companies have to do to entice savers back to shares?

For one, companies will have to give regular income to investors. This means increasing dividends, which implies squeezing cash out of the company to give back to the investor.

To achieve high dividend growth, a company will have to change the entire management value system that predominated in the boom years. In the boom, a good manager was the one who presided over growth, quarter on quarter profits, market share and getting bigger.

The major valuation tool of choice was the price/earnings ratio, with its forward-looking emphasis on tomorrow’s profits.

This benchmark will now change, and investors will reward the manager whose cashflow management throws off cash today rather than jam tomorrow. This means ripping up many of the MBA textbooks that have dominated management thinking in the past 20 years.

This change in culture (a change that is observed in every period following a boom) has enormous significance for savers. It means that the stock market itself may remain subdued for a very long time. Therefore, all these tracker indices that are the staple of the pensions industry are useless, because if they track an index that is not moving, there is no gain. Naive savers will be giving some office boy a fee for doing nothing.

The smart saver now has to look for the company that generates a yield every year over and above the rate of return on government bonds. You won’t find that by listening to the index sellers with their half-baked ideas culled from some investment bank’s monthly newsletter.

Today, with bonds yielding half nothing, finding such a company might not be too difficult, but this is unlikely to be the case this time next year.

Faced with salesmen whose major interest is in generating commission commensurate with their hot air, the road ahead is tricky for savers.

However, one thing is clear: if you want to enjoy your retirement, bask in the sun and have some keen, high spending youngfella bringing you drinks, beware the index pushers and their jam tomorrow.

Otherwise, flipping burgers at 76 becomes a real prospect — not a pretty picture.