In the long run the market is a weighing machine but in the short run it counts votes. Eventually, fundamentals will determine the right price but eventually can be a long time coming. In the meantime, being right at the wrong time is frustrating, career-threatening and expensive.
This is what John Maynard Keynes was getting at when he described investment as a beauty contest with a difference. You are not there to judge the most beautiful contestant but to guess who the other judges will rate. The sensible thing might be to temporarily do what you think makes no sense.
The vote-counting always comes to an end at some point but if the authorities are really determined they can disable the weighing machine for longer than you expect. And while that’s happening markets can do strange things. Fundamentals can simply be ignored.
In April, we have seen the fall-out from a landslide vote in favour of tech and bio-tech stocks. The weighing machine has been re-activated, perhaps only for a short while, perhaps for longer. If we’re really back to weighing not counting, however, then I suspect this process has further to go. The scales are a long way off balance yet.
Punchy corrections
There were some pretty punchy corrections in individual technology stocks, with the likes of Amazon, Facebook and Google off more than 4 per cent in one day (April 10) alone. And it’s been a global correction, with internet stocks under pressure from Shanghai to Silicon Valley and all points in between. With Nasdaq still trading at around twice the average multiple of earnings in the broader S&P 500, however, I think there’s still plenty of air to come out of this bubble.
Tech is not the only area of the market to have inflated on the back of central banks’ determination to keep investors optimistic. Four other areas look vulnerable to the kind of pull-back that has rekindled memories of the dot.com bubble.
First, Greece’s remarkable return to favour in the international bond market is a reminder that there’s nothing quite like the promise of looser monetary policy to tempt investors. With quantitative easing an option in Europe, why should anyone worry about a 25 per cent unemployment rate, anti-austerity strikes, exploding bombs or sky-high debts? Greece may be the weakest link but for the first time in years it looks like the chain might not snap. Perhaps that justifies Spanish and Italian 10-year bonds at 3.15 per cent. But accepting less than half a per cent more than you can earn on a US Treasury bond is quite a leap of faith.
Same medicine, different reaction
Europe’s equity markets are responding to the same medicine in a slightly different way. Here the cheap money is driving takeover speculation, allowing managements to dream up ways of buying in the growth that they are struggling to generate themselves. What else could justify last year’s rally in a region that’s exposed to slowing emerging markets, sluggish growth at home and sabre-rattling on its eastern border?
European equity valuations are as nothing compared to those in what is now laughingly called the high-yield bond market. Here the weighing machine has not just been switched off but thrown away. Globally, bonds issued by less credit-worthy companies are yielding around 5.5 per cent and little more than 4 per cent in Europe.
It’s true that the gap between junk bond yields and those on government paper is wider than it was in the pre-crisis hey-day for high-yield. Defaults are low too. But still, high-yield bonds look more and more like they should just be called bonds.
Desperate search
Which leaves property. In the residential market, the melt-up can be pinned on London’s haven reputation and a shortage of supply. But in parts of the commercial property sector, the reason for the boom is the same desperate search for yield that central-bank policy is determined to create. When talk turns to value in the Spanish commercial property market, then you know something strange is happening.
It’s fitting that this is the backdrop for the Bank of England and European Central Bank to start a campaign to re-invigorate the asset-backed securities market. Their motivation is good – to re-kindle lending to the region’s credit-starved companies – but if you think 15 years is a short wait for another tech-stock boom and bust then surely six years is unseemly haste for the return of securitised loans.
