It is that time of year when the big investment banks try to justify the vast amounts of money lavished on their research departments by presenting their annual forecast for the year ahead.
If I was running an investment bank, I would present the event from Stonehenge featuring old men in tunics and togas reading the runes and declaring we are all doomed – which is presumably why I will never work in such an institution.
The big bank presentations, by contrast, tend to be measured by the size of the graphs (the bigger and more logarithmic the better), the sheer quantity of impossible-to-read tables and the grandstanding predictions for the FTSE December 2010.
But there is one glorious exception to the rule – Socgen’s annual Rock and Roll Love In/Strategy Update. This featured the top trio of analysts – economist Albert Edwards, strategist Dylan Grice and quant hero Andrew Lapthorne – plus extra special guest star James Montier, released from gardening leave hell (before joining GMO) to regale the audience with his ‘I told you so’ prognostications on why investors ignore behavioural finance at their peril.
This rather strange event is part City presentation – Hawaiian t-shirt clad men addressing mass of suits – part rockstar gathering.
The real measure of the success of such an event though is not the theatre but the hard analysis accompanied by genuine insight. Yet again the SG team trounced the opposition.
Whereas most big bank analysts are wont to pontificate on big themes, global shifts, and fave companies to play the cycle, the SG team present an overview that has, I think, a number of compelling features for any long-term investor.
Economist Albert Edwards believes as deleveraging grinds through the system, attention will inevitably be drawn to the massive inequalities of income that are emerging and this “extreme inequality will disrupt both corporate profits growth and social stability”.
Quant strategist Andrew Lapthorne reminded us all the best way to time any entry to and exit from the market on a short-term basis is look at the earnings announcement cycle in the S&P 500. Buy just before earnings are being upgraded and before the earnings season starts and then sell when its winding down.
According to Lapthorne, an astonishing 50% of previously raised estimates are then downgraded in the following period. Lapthorne also drew attention to the astonishing gap between US pro forma reported earnings per share (EPS) and the reported operating EPS – its currently at 20-year highs with a 1.6 x discrepancy.
Cash levels at major companies are at all-time historic highs – they are typically at 6% of total market cap but currently it is 11%. Most of that cash will be badly spent on M&A activity, which drives markets higher in the short term but crushes earnings in the next down cycle. It is also a fair bet most of that M&A activity will probably be in the cash-rich quality stocks – big blue chips with lots of decent businesses and a decent dividend.
Strategist Dylan Grice reminded us “our governments are insolvent” and, after including net liabilities, debts total near 400% of GDP in the UK and over 500% in France. Japan is already at the point of no return where savings are starting to run down because of an ageing population.
If the Japanese cannot afford to fund those massive deficits, the government must look abroad and be willing to pay much higher rates, rates the government simply cannot afford bearing in mind the astonishing fact the key bond issuance to tax revenue ratio is already just under 100%.
The last and most powerful observation comes from Grice – and it is one I think should be inscribed on all advisers and asset allocators collective memory. As a massive credit surge in China feeds into an asset bubble and a massive increase in over-capacity, volatility beckons.
Volatility also ensues in each historical era as a new geopolitical force emerges. Investors tend to treat volatility as their arch enemy but Grice reminds us that all peaks in the measure of vol also coincide with peaks in the supply of bargain stocks on the market.
Grice also reminds us of Gerald Loeb, one of the most successful US financiers and founding partner of EF Hutton who noted “profits can be made safely only when opportunity is available... willingness and ability to hold funds un-invested while awaiting real opportunities is a key to success in the battle for investment survival”.
David Stevenson is a Financial Times columnist and consultant. Email him at davidcstevenson@gmail.com
