For many fund managers, the arrival of January means primarily one thing: the latest investor conference from the Société Générale team of perma-bear analysts, led by Albert ‘Ice Age’ Edwards. In fact, this description is somewhat unfair, given that Albert’s two bearish partners in crime, James Montier and Dylan Grice, have both gone on to work in pastures new over the past few years. Nevertheless, Dylan rejoined Albert on stage for 2018, which offered at least a partial opportunity to get the band of bears back together.
The SocGen team (or now, Albert and his colleague Andrew Lapthorne) regularly win awards for the quality of their research. Attendance at their annual London conference is often treated as a contrary indicator with regard to the health of the markets. A conference packed to the rafters equates to huge interest in their bear thesis, which invariably means that markets outperform in the subsequent year – the so-called ‘climbing the wall of worry’ argument that has made this latest rally by Anglo-Saxon and especially US stocks to be regarded as one of the most unpopular rallies in history. A conference thinly attended, on the other hand, equates to huge levels of complacency, which invariably means that market returns in the subsequent year tend to be disappointing. This year, the conference was well attended but there were still gaps in the crowd, which means… well, I’m not sure we can deduce anything sensible from that.
But Albert and team are nothing if not thought-provoking. And Albert’s a realist, who’s well aware that his continued warnings of a day of reckoning for stocks sound like a broken record, or the proverbial stopped clock that might yet be right twice a day. And in his defence, the rally for risk assets, but notably stocks, that began in March 2009, at the height of the Global Financial Crisis, has defied just about everybody in its length and intensity. He even has a sense of humour about it, pointing out that one financial journalist described his advice as “how to correctly predict ten of the last one market crashes”.
So, for many investors and market-watchers, the rally of 2009-? just keeps on chugging, in the face of historical precedent, high levels of corporate leverage, significant stock buyback activity, valuations, and plain reality. Will 2018 be the year that the market finally responds to gravity?
Central bankers could be the first to discover this year that the forces of gravitation have yet to be rescinded. It is surely their grotesque dollops of Quantitative Easing over the past decade that have propelled so many otherwise relatively fragile equity markets to fresh highs. And Albert is careful to quote Sir Mervyn King, the then Bank of England Governor, in February 2012, when he said,
I have absolutely no doubt that when the time comes to reduce the size of the [Bank of England’s] balance sheet that we’ll find that a whole lot easier than we did when expanding it.
As a marker of insane hubris, that has to be on a level with outgoing Federal Reserve Chair Janet Yellen when, at an event in London last June, she was asked about the likelihood of another financial systemic shock:
Would I say there will never, ever be another financial crisis? You know probably that would be going too far, but I do think we’re much safer and I hope that it will not be in our lifetimes, and I don’t believe it will be.
Hmm. We’ll get back to you on that one, Janet.
The day when the last bear capitulates is when it’s really time to start battening down the hatches.
Much of the SocGen conference material this year went over already well-trodden ground: markets seem to have abandoned any conception of respecting valuations; the Shiller cyclically adjusted price/earnings ratio (the so-called CAPE) for US markets now puts them at their second most expensive level in history; 2017 saw bumper central bank money printing; the stock exposure of individuals is also at its second most expensive level in history; professional advisers remain extremely bullish; equities are, for the time being, ignoring rising bond yields (this could be the biggest red flag of all for 2018); inflationary pressure is seemingly quiescent just about everywhere; companies, especially in the US, are still aggressively buying back their own stock, even if they have to borrow to do so.
But there were two slides that really stood out, at least for me. One of them showed that as a percentage of global profits, those made by US and Japanese companies had largely held their own over the last 15 years or so. The percentage of global profits made in emerging markets grew quite sharply over the same period. But the percentage of global profits made by European companies roughly halved – from 40% of the MSCI World Index in 2002 to just 20% in the last couple of years. This is a damning indictment of European corporate health, and precisely the reason why many of us voted for Brexit in 2016 – because the European economy is fast becoming irrelevant on the global scene.
The second SocGen chart that caught my eye was on a related theme. It showed that Japan (population: 127 million) was now generating the equivalent of 50% of European profits (population: 743 million), as shown by reported earnings for MSCI Japan versus MSCI Europe in US dollars. That is a real eye-opener, especially when you consider how out-of-favour the Japanese stock market remains. Albert’s colleague, Andrew Lapthorne, went on to say that Japan’s problem was never a fundamental economic one; rather, its stock market simply got too expensive during the 1980s, and so it spent the next quarter century in the doldrums. There is a lesson for the other developed markets here, and it is not an encouraging one.
Everybody hates bears
The problem with bearishness is that just about everybody hates bears, especially when they’re right. The distinction between being ultimately right and being right in respect of timeliness, however, is a subtle one, and most bears have been caught out by – with hindsight – being fantastically premature.
A case in point is US money manager John Hussman – whose latest commentary you can read here. I don’t know Mr Hussman, but he writes well, and with intelligence. But US financial advisor Lawrence Hamtil has written a damning piece about Hussman’s prolonged bearishness that makes for awkward reading for any bear, and not least Hussman in particular. Among the highlights, for example:
Since the publication of [his] November 2010 article, the S&P 500, which Mr. Hussman has repeatedly warned us has been in a bubble, has returned over 100% on a total return basis. It must be exhausting – not to mention humbling – to be so dedicated to an idea that, despite all your evidence to support it, is repeatedly rejected by investors who have continued to bid shares higher and higher.
In fact, since the current bull market began in March of 2009, Mr. Hussman has repeatedly called for a titanic decline in the S&P 500, but, in a twist of irony, it has been his own fund, Hussman Strategic Growth (HSGFX), that has suffered a disastrous bear market all its own with a peak-to-trough decline of almost 50%.
Mr. Hussman’s mania over perceived bubbles has almost a sinister aspect to it. This obsession with prophesying doom no matter what makes Mr. Hussman resemble the naysayer of which Pascal Bruckner has written, “[H]e becomes intoxicated with his own words and claims a legitimacy with no basis… Catastrophe is not [his] fear, but his joy. It is a short distance from lucidity to bitterness, from prediction to anathema.”
Investing is an extremely difficult endeavour, and most will fail at it. All the charts in the world that show stocks have averaged X return over Y period of time are useful only to the extent that investors realize that there were countless periods when stocks lost 10, 20, and even 50% along the way to averaging those returns. While we should heed the counsel of wise men, we should be on guard against the Cassandras like Mr. Hussman, who have wedded themselves to an idea, and who point an accusatory finger at those of us who, having seen the weight of evidence, choose to ignore their warnings. It is to the great misfortune of Mr. Hussman’s shareholders that he has been more preoccupied with being right about the inevitable doom of our investments, at the expense of ignoring the catastrophe suffered by his own.
Ouch. Let he who is without sin cast the first stone.
I’m minded to believe that most investors now suffer from some form of crisis fatigue. The effects of the Global Financial Crisis – huge market instability followed by the mother of all reflationary attempts by the world’s central banks – have distorted so many markets and been with us for so long that it is tempting just to go with the flow; to capitulate and, to paraphrase the infamous Hugh Hendry, simply buy just about everything. But that would be a dereliction of duty for those of us whose primary responsibility is to preserve our clients’ capital. The day when the last bear capitulates is when it’s really time to start battening down the hatches. Are we that much closer to a sea change in markets in 2018? Both logically and statistically, we must be.