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Weekend reading: Strong recoveries and weak constitutions

Weekend reading: Strong recoveries and weak constitutions post image

My weekly reflection, plus the week’s top links.

Quick! Sell any shares you were foolish enough to buy, hoard gold and government bonds, and avoid paying taxes because Government quangos will only flush your money down the toilet while singing Don’t Cry for Me Argentina.

Heck, if you can’t beat them, join them.

At the start of the year I wrote Britain was booming – a slightly hyperbolic title I admit, but also a deliberately provocative one that turned out to be right. Back then, nobody had anything good to say about the UK economy, and the spectacular rise in share prices in the months prior was blamed on cheap money.

It’s been the same story all year here, in Europe, and in the US, as I’ve chronicled on my Stock Tickle blog (now on hiatus, due to time constraints).

Yet people far prefer to read doom and gloom disaster stories from people who sound wise by not sounding happy.

As I’ve written before, the bear case always sounds smarter. Writers – particularly bloggers and newspaper columnists – can’t tell us enough how the US recovery is a limp-wristed thing that will end in President Obama selling California to the Chinese to make interest payments on the US deficit.

Yet in reality, this is actually on some measures the strongest US recovery for 25 years, as the FT reports:

The current US economic recovery is widely perceived as the weakest ever, syncing with the popular idea of a “new-normal” economy. Although this recovery is not as strong as those of the 1970s, on many metrics its first year anniversary has proven stronger than either of the last two recoveries during the previous 25 years.

Despite a significant slowdown in the second quarter of this year, real GDP growth in the first year of this recovery was 3 per cent compared with first year recovery gains of only 2.6 per cent in 1991 and 1.9 per cent in 2001. Persistent private job creation took 12 months once the recession ended in the early 1990s and it took 21 months after the 2001 recession.

This recovery began producing persistent private job gains only six months after the recession ended. Moreover, in the first 14 months of this recovery, 205,000 jobs have been lost. While this is surely disappointing, it compares with 220,000 and 935,000 cumulative job losses respectively at this point in the 1991 and 2001 recoveries.

Obviously if you’ve not got a job or you fear losing the one you have, things are terrible. But that’s always the case – not just at the end of recessions. Besides, as I’ve stressed many times, unemployment is a lagging indicator.

I’m not blind to the problems. The US house market crash has led to permanent wealth destruction, and we still look overdue a proper correction in the UK. (I rent, but hedge my bets with Lloyds shares). The US is still growing, but more QE is mooted in the US because inflation remains stubbornly low. I’ve been wrong about government bonds all year for the same reason.

Consumer confidence also remains miserable – not surprising perhaps, given the torrent of bad news hurled at them daily through the press and on the Internet.

In reality though, investors make money when they buy companies at cheap prices that go on to do well, not when some bloke in the pub thinks China is a friend not an enemy, or when his sister feels happy enough to buy a buy-to-let property in Torremolinos again.

And corporate profits have been soaring as the global economy has continued to expand. S&P 500 company profits will  be up about 45% in 2010, and are forecast to rise 15% next year.

Companies are so financially sound – and debt is so cheap, due to low interest rates and perma-bearish investors preferring to buy Microsoft bonds with the lowest yields on record, instead of its cheaply rated stock – that they’ve begun to snap each other up like ladies who lunch buying Jimmy Choo’s back in the boom.

None of this puts shares in the bargain basement; on a P/E basis they look good value, but on a capital cost replacement they look a bit expensive.

The time to really snag bargains was last March, at the height of the bearmania. Unfortunately for those who followed the gloomy consensus, such opportunities come once a decade at best.

By all means keeping reading the bearish blogs, and hear both sides of the argument. But remember many such writers will never change their tune.

They’ll either quietly start talking about stocks they bought six months ago, despite their publicly gloomy convictions. Or else they’ll disappear until the next recession and crash comes along, when they’ll try to say they told you so – regardless of the good times in between.

From the blogs

From the big sites

  • ‘Flash crash’ caused by one single order – The Economist
  • Ireland’s bottomless bailout bill – The Economist
  • Back to basics in the porn business – New York Times
  • The BP-spill baby turtle brigade – New York Times
  • The market war between traders and investors – Wall Street Journal
  • Your ETF will not collapse – Morningstar
  • 12 shocking mutual fund statistics – Morningstar
  • How Jim Slater sieves for gold shares – Motley Fool
  • Is stock picking dead… – Motley Fool
  • …or does ETF growth leave excess returns on the table? – FT
  • 1 in 4 hedge fund employees leaving the UK – FT
  • Free money apps for UK iPhone users – FT
  • Handsome rewards from high-yielders – FT
  • Bonds funds: Time to jump ship? – Telegraph
  • Ten tips for lazy personal finance – Telegraph
  • The Great Haul of China – The Independent
  • What to do if the tax man writes – The Independent
  • Financial journalist waves goodbye to Barclays – Guardian

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{ 6 comments… add one }
  • 1 RetirementInvestingToday October 2, 2010, 11:48 am

    Hi TI
    As always a thought provoking post. Essentially be contrarian and buy when everybody else is talking doom and gloom. Sounds reasonable to me although to prove I am not contrarian I am currently underweight equities as I see over valuation in equities 🙂
    .-= RetirementInvestingToday on: The challenges of value investing =-.

  • 2 ermine October 2, 2010, 2:20 pm

    > None of this puts shares in the bargain basement; on a P/E basis they look good value, but on a capital cost replacement they look a bit expensive.

    One of the items I dropped in my piece for journalistic reasons was that P/E ratios look good at the moment. I started investing in the late 1990s, where I was used to P/E > 20. Ten years older and hopefully wiser, I don’t do that sort of thing now. Another observation is that yields seem to be relatively high in the UK, particularly when compared with the derisory returns on cash.

    BTW What is capital cost replacement? I can understand what in means in terms of repair/replace/scrap a piece of equipment but for shares it’s not clear to me.
    .-= ermine on: Best September for 71 years for the Dow – but is it real =-.

  • 3 Salis Grano October 2, 2010, 4:44 pm

    I tend to agree with the generally optimistic scenario, but I think it is going to be a bumpy ride and for many sound companies there may still be better times to buy — at least, I hope so. -SG
    .-= Salis Grano on: Financial Roundup 1-10-10 =-.

  • 4 The Investor October 3, 2010, 10:19 am

    Thanks for your thoughts guys.

    @ermine, I mean the likes of Tobin’s Q , which basically boils down (via a lot of debate and academic fuss and bother) to the relationship between market valuations and book values (with the latter as a proxy for replacement cost).

    i.e. What is a company selling for on the market, compared to what it would cost to rebuild it from scratch?

    I’m not an expert or a great user of it, not least because academics seem to disagree on what it is (because as you imply how do you account for intangibles like goodwill, or a company’s competitive position?) and also what it means (a high Q, while often perceived of as a bearish signal of over-valuation, could imply a rising popularity of risk investing, which can be self-fulfilling).

    You can immediately see the difficulty if you think of a company like Coca-Cola, with all its intangibles and reach.

    The investment manges Smithers & Co is a big proponent of this approach in the UK, and quite bearish for Q based reasons at the moment IIRC. You can find more on its website.

  • 5 Bret @ Hope to Prosper October 3, 2010, 8:04 pm

    Supposedly, this was the best September for the S&P since 1873.

  • 6 Mark October 9, 2010, 9:23 am

    I’m not unsympathetic to the bears but I hear you – they also lost out in one of the strongest 12 month runs ever. As they seem destined to do each time.

    Personally, I find it difficult to organise and understand the various seemingly contradictory news items and reports into a strong view either way. The largest nagging issue to my mind is how weak the US and UK consumer is still supposed to be but corporate earning forecasts so strong. Professionally I am strongly supportive of some of the good performance in emerging markets, where the financial systems didn’t wobble and consumer spending is growing nicely.
    .-= Mark on: The 10 most important guidelines to investing =-.

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