By Stephen Corley
Analysts have again proved that when it comes to predicting the future, their guess is as good as anyone's. There is a story that economists use to illustrate the valuation of assets.
|~||~||~|Analysts have again proved that when it comes to predicting the future, their guess is as good as anyone's.
There is a story that economists use to illustrate the valuation of assets. Once upon a time, a trader bought a tin of sardines for $1 and sold them to a rival for $1.50. This trader in turn sold them for $2 and so on. Years pass, until the current owner came upon a man willing to pay $10. The buyer, who was famished, opened the tin only to find that the sardines were inedible and was rightly indignant. ‘But you don’t understand,’ the vendor said. ‘These were trading sardines, not eating sardines’.
The moral of the story is that assets are worth, ultimately, what someone is prepared to pay for them and that price may be a poor reflection of their real value. The anecdote is useful because it has not gone unnoticed by a fair section of the world’s press that pretty much every asset one can think of is fundamentally overvalued. Whether or not we are in a giant bubble with only one outcome is an argument that could fill this entire magazine. However, at least one major global publication has forecast that the only real end can be either a huge fall in asset prices or serious inflation.
Looking at today’s inflated asset markets, a strong parallel exists in reverse with the markets of twenty five to thirty years ago. It offers potentially the same lessons. All investment markets were, apart from commodities, extremely depressed. In addition, with the Dow Jones at the same level as it had been in the early 1960s, nobody could contemplate that it could rise 20% let alone threefold, as predicted by proponents of the Elliot Wave theory. Cash was king, commodities were in strong demand and nobody wanted to touch bonds
Today, on the other hand, it seems as if investors, driven senseless by low cash returns, are on the rampage. These latter day prospectors dig out investment opportunities from Bulgarian real estate to gold mines in Nicaragua. Bonds are being driven to derisory yield levels and there is a bubble of alarming proportions in UK Government debt.
Calculations by The Economist magazine show that house prices have hit record levels in relation to rents, in America, Britain, Australia, New Zealand and most of Europe. This suggests that homes are even more over-valued than at previous peaks, from which prices typically fell in real terms. House prices are also at record levels in relation to incomes in all of these countries.
In equities, bubbles are developing to mirror the dotcom craze. In the GCC we had already moved into the realm of astrology rather than economic analysis so perhaps we should heed the Bradley Model, amusingly favoured by noted contrarian Dr Marc Faber, which is based on planetary alignments. The Bradley model correctly called the current US stock market rally by bottoming out in December 2005 and apparently will turn down again in November 2006. Given my comments in Arabian Business on the less than illustrious track record of most Wall Street strategists and analysts, I believe its record compares rather favourably.
However, if there was a massive sell-off of assets around the world, even remotely along the lines last seen in say, 1998, this could conversely produce demand for safe havens such as gold and of course cash. But in which currency?
Any collection of press cuttings from the last two years has just about every professional financial commentator predicting the collapse of the US Dollar. Naturally analysts have been rattled by concerns that foreign central banks might reduce their holdings of US Treasury bonds. Officials at the central banks of both Russia and Indonesia are on record that their banks are considering reducing their dollar reserves. Reports that China’s central bank intends to trim its purchases of Treasuries and switch some of its reserves to currencies other than the dollar adds more fuel to the concern. This combination of events has led some to ponder the once unthinkable: might the dollar lose its reserve-currency status?
Of course, the deficit is at the heart of this issue. Various economists have put forward at least four arguments why the deficit does not matter and the dollar’s reserve status is safe. First, it’s a sign of America’s economic might, not a symptom of weakness. Second, sluggish demand overseas is a big cause of the deficit, hence it is reversible. Third, the deficit exists largely because of multinationals’ overseas subsidiaries. And fourth, central bank demand for dollars creates, in effect, a stable economic system. It is not difficult to demolish each argument in turn and this has been done credibly. Yet the dollar remains defiant and appears to wrong foot the pros at every point.
So despite everyone calling the reverse, is the dollar still a sound cash bet? As Joe Granville pointed out in the 1970s, an investor should basically stand on his head and act in advance of when favourable or unfavourable news hits the market i.e. buy on the rumour sell on the fact, because the market will have reacted long before the information is out in the open.
Stephen Corley is a business consultant with experience in fund and asset management. He can be contacted at email@example.com||**||