Which stock market oracles should you trust?
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“The market is cheap. The market is dear,” puzzles Philip Coggan in the FT, quoting an unlikely source – poet Walt Whitman – in the hope of making things clearer. “Do I contradict myself? Very well, I contradict myself. I am large, I contain multitudes.”
“Multitudes” is a fair word. There is a glut of indicators pointing the way forward for stockmarkets; the problem is that they point in very different directions. Bulls are cheered by relatively low price/earnings (p/e) ratios for equities and by high dividend yields relative to bond yields. Bears favour other figures, such as cyclically adjusted p/e ratios and replacement cost of assets (the q ratio), which suggest that equities are heavily overvalued.
But both camps may be missing the point. While valuations may be useful to those investing on very long timescales, they are very poor at forecasting near-term market returns, as Coggan points out. He cites research by Chris Watling of Longview Economics, which shows that since 1871 there has been almost no correlation between the S&P 500’s p/e ratio and its returns over the next 12 months. Even überbears such as Robert Shiller, the major advocate of the cyclical p/e measure, agree that it can take many years for overvalued markets to correct fully.
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So what oracles should investors consult? Take a “cooler look at fundamentals”, advises the FT. There are four main risks to equities. The first two – a falling dollar and a weaker US housing market – are well-known. The others are less discussed, but also worrying: whether the “Goldilocks economy [strong growth and low inflation] is a fairytale after all” and whether corporate profits can stay high.
Economic cheerleaders, such as Goldman Sachs’s Peter Oppenheimer, remain optimistic. His recent paper, The Globology Revolution, argues that low inflation and strong profits are the results of a combination of lower
costs (from globalisation) and new technology that has much further to run. But concerns are growing. For example, the OECD thinks that in the short term, the benefits of globalisation will be offset by the high price of oil. As Liam Halligan puts it in The Sunday Telegraph: “Goldman Sachs paints a bright picture of the future. The trouble is, we should be more worried about the present.”
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