September 14, 2015
For a documentary going out on RTE One the week after next on wealth in Ireland, we explored the recent returns to the stock market. In order to get a sense of the value of companies based here in Ireland, the team constructed a bespoke index, which measured the stock performance of the top ten US multi-national corporations that have part of their global business here in Ireland.
The results were quite dramatic, not least because we contrast this index with an index of Irish wages. The aim is to show how you’d be fixed now had you depended on stocks for your household income, rather than depending on wages. We look at the evidence from 2008 to 2015.
Households that depended on wages have seen hardly any increase in income, but the households that depended on stocks – no matter how small the investment – are looking at a tidy 470 per cent profit.
Let that sink in for a minute.
Before we launch into a story about how easy it is to make money of stocks, calm down. Picking the year 2008 as the beginning of the financial crisis is a bit unfair because it represents a recent nadir for stocks. Markets crashed in 2008. In addition, the policy reaction to the financial crisis was quantitative easing which was explicitly designed to drive up stock prices in order to repair the balance sheets of the US investing public.
Therefore, we are looking at possibly an exceptional period in financial market history when the main economic policy was focused on balance sheets and driving up asset prices, including property.
This policy reaction led to the presumption that every time there was a wobble in stock prices, central banks would come in and inject more cash into the market sending prices back upwards. It’s not that central banks decided to love financial markets all of a sudden, but they decided that the financial market is the battleground through which they will win the economic war of dragging the world out of recession.
This background noise substantiates the observation that sometimes, when investing, the best of decisions are taken in what appear to be the worst of times and the worse decisions are taken in what appear to be the best of times. 2008 was the worst of times.
So for six years financial markets have been on a rollercoaster of cheap money, leading to upwards stock prices, leading to more confidence, leading to ever higher stock prices. This is precisely the opposite of what was happening in the normal economy, where competition from China kept downward, not upward pressure on manufacturing wages.
But over the summer, the upward march of markets came to a sudden halt – driven largely by fears over China and, more fundamentally, by the acknowledgement that, in the US, the period of easy money is over and the next move in interest rates will be upwards.
Stocks have all fallen dramatically, the dollar has risen, and this has pushed down commodity markets further and led to billions of dollars leaving all sorts of risky assets.
Contagion from China’s 40 per cent stock market meltdown has triggered bear markets from Hong Kong to Frankfurt, and plunged Asian/emerging markets equities into a ghastly replay of 1998’s epic meltdown.
Just to remind you what happened then, we had General Suharto’s overthrow in Indonesia, the Russian rouble default, Malaysia’s capital controls, the run on the Thai baht, the IMF’s $57 billion South Korea bailout and oil prices down as low as $10 a barrel.
But back then, the Fed responded to the crisis by cutting rates and injecting money into the system.
Now the likely move in Fed rates will be upwards because the US is growing so strongly.
After six years of zero interest rates, the US authorities are about to declare victory. The day rates are raised in the US will be a valedictory moment. It will mean that the Fed’s policy has worked.
Let’s look briefly at the US numbers to understand this point. The economy is growing at close to 4 per cent, the unemployment rate is down to levels lower than when Reagan was in power, the banks are lending again, commercial property is rocketing and the banks’ balance sheets are in good shape.
So it would not be surprising for the US to raise rates this week, despite calls from both Larry Summers and the chief economist of the World Bank for the Fed to chill out and wait until the rest of the world looks better.
Most people in the US have discounted a US rate rise anyway. So why should the US stock market slump further?
Elsewhere, ongoing deflation is going to make the ECB miss its inflation target, again. The situation in Europe is the polar opposite to the US.
The ECB has just downgraded again its growth and inflation forecasts in Europe, and is actively preparing the ground for another massive round of European quantitative easing.
In the past two weeks, the German DAX index dropped 20 per cent from its peak since its blue-chips have 10 per cent of their sales in China. It rebounded this week, but we are still yo-yoing around. The Swiss market did the same; as too did the Italian market.
But unlike China, there is no sign of recession anywhere in Europe. There may be worries about inflation, but the economy is no worse than it was a few months ago, and industrial Europe is doing well.
So it looks like there is value in Europe.
The key to this game is to buy when you think stocks are cheap and really just go away and allow the companies do their thing.
The idea that you can beat the index or be cleverer than the next guy seems to me to be a recipe for many sleepless nights. Also, if you do want to sleep, avoid leverage because this is a way to bankruptcy.
If you are content to buy good companies that have good cashflow and a history of giving investors back their money via good dividend payouts, now is a good time, because the market has been indiscriminate in punishing everyone.
So yes, there is opportunity in this market no doubt, but in stocks, it is the underlying companies you want to understand.
A great example of this could be the well-managed multinationals that operate here. They are in a variety of sectors, are plugged into the world market and are based in an economy which is growing at six per cent per year, yet where their costs are kept down via the low corporate tax rate.