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Weekend reading: Profit potential in mass hysteria

Weekend reading

The best of the week’s money articles.

I don’t expect corporate earnings to collapse. I don’t expect a renewed recession, let alone the Depression so cavalierly predicted.

Could we get a recession? Sure – we always could, at any time.

A Eurozone break-up would probably do it, just like the gloomy say. If I thought it was a serious possibility, I’d hold far fewer equities, at least until it happened.

What I think is much more likely is that Western economies will continue to bump up and down, as corporates fail to squeeze much more juice out of their hard-pressed and increasingly skint workers, whilst continuing to enjoy the fat of the land from developing markets.

That might not sound particularly gangbusters, but it’s got us this far. Investors over the past month have been predicting something different, wiping roughly 20% off share prices that weren’t very stretched to begin with.

Citigroup has crunched some numbers on what happens when markets fall 20% but earnings fail to follow the script and don’t collapse:

That’s the sort of bet I like making. Unfortunately the source, Business Insider, doesn’t give any more detail on how this data was constructed.

No worries though, because adding to equities for the long-term is common sense right now.

UK gilts haven’t yielded so little since Britain had an Empire. Yet P/Es on shares are low and the market’s forward dividend yield is at least 1.5% over gilts (and likely more). Corporates are awash with cash – and occasionally even spending it. Hewlett Packard’s purchase of FTSE 100 firm Autonomy for a 75% premium seems far closer to me to an accurate valuation than the prices the trading robots and summer interns are putting on shares.

And valuations are what matter, not investors’ manic depressive swings.

The market may well be right, but it will be wrong tomorrow – it’s inevitable, because it’s swinging more vigorously than Ron Jeremy after putting his car keys into a bowl at a party in Berkshire.

I wouldn’t trust a nutter like Mr Market to buy my popcorn. I’m certainly not about to trust his judgement with my money.

From the blogs

Book of the week: For all you naughty active traders and stock market obsessives out there, Amazon is taking pre-orders for this year’s legendary Stock Trader’s Almanac. It’s due out soon!

Mainstream media money and investing

  • Warren Buffett: Stop coddling the super rich – New York Times
  • Buying farmland delivered a 16% gain last year – Bloomberg
  • Europe and the Euro: The bonds that tie, or untie – The Economist
  • The decline of Asian marriage – The Economist
  • The seven highest yielding Buffett stocks – Motley Fool
  • Poof, it’s gone! [Old video, almost relevant again!] – South Park / YouTube
  • Is the UK and America turning into Japan? – BBC
  • Former Soviet Republics: Winners and losers [Graphic]BBC
  • Drip feeding profitable in volatile markets – FT
  • Volatility puts pensions at risk – FT
  • Lenders cut rates in home price war – The Independent
  • [And people wonder why I don’t get married]The Independent
  • How to invest in… Romania – The Independent
  • Half of would-be first-time buyers given up on owning – Telegraph
  • Goldman Sachs staff furious at pot plant cutbacks – Telegraph
  • What sports stars blow their money on – Telegraph
  • British Gilt yields lowest since 1890s – The Guardian

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{ 11 comments… add one }
  • 1 The Money Grower August 20, 2011, 8:58 am

    Thank you for the inclusion, Mr Monevator.

    Currently working my way through your recommendations.


  • 2 RetirementInvestingToday August 20, 2011, 2:45 pm

    Hi TI

    Some PE10 valuations:
    1. S&P500 at 19.4 against an average since 1881 of 16.4 or since 1993 of 26.8. Overvalued?
    2. FTSE100 at 11.7 against an average since 1993 of 19.6. Extrapolate to 1881 gives 12.0. Fair value?
    3. ASX200 at 14.6 against an average since 1993 of 22.4. Extrapolate to 1881 gives 13.7. Overvalued?

    IMO the markets are starting to head back to a neutral value point and some markets could even be starting to reach fair value. It will be interesting to see what will happen long term as the baby boomers now start to retire and start to sell their equities to live off or buy annuities with. Just how much influence does this element hold over the market…

    My mechanical strategic allocation combined with some PE10 tactical forced my hand this week. I was forced to sell 20% of my gold and with the proceeds bought UK & EU equities and EU property. All low cost index trackers of course 🙂

    Only time will tell if it was a good move.


  • 3 The Investor August 20, 2011, 9:44 pm

    @RIT – Hmm, thanks for that. I had hoped perhaps the recent falls would make them more definitely ‘buys’ by the PE10 criteria.

    As I’ve probably said before, I’m a bit skeptical about PE10 as the be all and end all, although fine as part of my overall mix. Presumably the big earnings of YE 2000 are now dropping out. We’ve got two recessions in the mix, pulling down earnings, too. It seems rather arbitrary to me.

    That said your mechanical strategy certainly seems to fit with my thinking, so I guess I could be replaced with a robot!

    Also: Good to see you’re still with us!

    @MoneyGrower – No worries, thanks for dropping by.

  • 4 John @ UK Value Investor August 21, 2011, 12:29 pm

    Thanks for the mention. Regarding your comment on PE10 above, RIT is the main man for PE10 data, but I’m not super keen on extrapolating back to 1881 for technical reasons that would bore a rock to death.

    Looking back to just 2003 when shares returned from la-la-land, we’ve got an average of about PE10 of somewhere between 15 and 16. This includes mild boom and big bust and big rebound, so it’s a fair period I think.

    Currently we’re at a PE of 11 something, so I would say it’s pretty cheap. If I were rebalancing today (FTSE at 5000) then I’d put about 90% into a FTSE 100 tracker. 90% because I don’t do all that global/commodity/REIT diversification, I’m just a plain vanilla UK stocks/bonds man. So of course the 10% would be in government & corporate bonds.

    The 90% figure is mechanical and based on findings in the ‘valuing wall street’ book, but again, I won’t bore with the technicalities.

    Happy hunting…

  • 5 The Investor August 21, 2011, 12:50 pm

    @John. Thanks for that, agree that sounds a more reasonable period though still obviously an arbitrary one. (I presume people have looked into PE20?!) Anyway, I don’t want to knock PE10 for the sake of it — for a start I asked RIT for the data and he kindly supplied it! — and I know it’s one of the more useful market timing metrics out there. I’m dubious it can be used in isolation, although that said it’s telling RIT roughly what my own research is telling me to do, so it can’t be all bad (or else we both are…)

    I’m curious that you bracket government bonds together with corporate bonds. To me they’re night and day, and usually if I was adding bonds it’d be for defensiveness and hence the government variety. (I touched on this back when corporate bonds actually looked attractive in early 2009). Appreciate you say it’s mechanical though, so you’re following the numbers I guess.

  • 6 ermine August 21, 2011, 8:51 pm

    [Eurozone] If I thought it was a serious possibility, I’d hold far fewer equities

    I know I am of a more jumpy temperament, and your previous post notwithstanding – it seems clear that there’s a lot less common cause between, say Germany, Holland and the PIIGS than the States of the United States. Sharing a common language would be a good start. The EU itself, fine, but a single currency, instead of say currency blocs? There seem to be fundamental inconsistencies between lifestyles and economic aims across the continent.

    Can’t quite see the fiscal United States of Europe working well, and the US itself was forged in the youth of the empire, rather than the Autumn/Winter phase of the Spenglerian cycle.

  • 7 The Investor August 22, 2011, 8:23 am

    @ermine — I agree with you that Europe is a debacle! 🙂 My views haven’t changed much since 18 months ago when I first argued the ECB would start buying peripheral bonds sooner or later, and that somehow the rich countries would bail out the poorer.

    But that’s not because I think the Euro is a sound monetary project — I definitely don’t! The European Union was an excellent venture, turning Europe into trading bloc rather than its historical battlefield, but integration beyond that was hubris and myopia.

    So I agree with you — except that we’re 15 years too late and the Euro *does* exist. My belief is that now it’s here, it’s probably just too costly and painful to unwind… a bit like realizing halfway through rowing across the Atlantic that you should have brought a sail. What are you going to do — stop rowing?

    By serious possibility of break up, I suppose I mean “likeliest”. I’d guess there something like a 10% chance in the next year, rising to perhaps 20% over the next 5-10 years. These are just finger in the air numbers! If I had was guessing say 75%, I’d have been much more bearish and defensive going into this year.

    Thanks as ever for comments!

  • 8 Brave New Life August 22, 2011, 10:25 pm

    That chart is humorous. Basically, the average response to a 20% drop is a 20% rise back to where it was… I suspect a quick 20% rise is normally followed with roughly a 20% drop.

  • 9 The Investor August 22, 2011, 11:08 pm

    @BraveNewLife — It takes a 25% rise to make up for a 20% decline.

    Easy mistake to make, but also an important investment lesson: it’s easier to lose it than to make it…

  • 10 John @ ukvalueinvestor.com August 29, 2011, 7:24 pm

    Slight delay in answering! Anyway, there have been studies into PE10, 20, 30 and Tobin’s Q. That’s the order of predictive power too, but nobody ever seems to have data on Tobin’s Q and PE10 is easier to calculate yourself. Also, PE10 is ‘good enough’ I think to act as a guide, which is all these things can ever do. Houses looked crazy expensive in 2003, and look what happened after that! Still the best part of a decade’s correction to go in housing I think.

    As for gilts/corporates, I’m just not that into bonds, so I only look at index tracking baskets of gilts and AAA rated corporates. When looking at those indices they just seem to have some volatility and a reasonably steady coupon, with corporates typically yielding slightly more.

    I just see them as something that isn’t well correlated with stocks (for rebalancing) and gives an income at the same time. I only use them in my passive portfolio.

  • 11 The Investor August 30, 2011, 9:06 am

    Sounds sound enough John, thanks for coming back and elaborating.

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