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Investment view

Here is an uncomfortable thought for all you advisers who base your recommendations around investment products that concentrate on equities – this may not be a bear market extending longer than usual.

Instead, it could be a continuing correction to a market aberration that started in the early 1980s and continued until the turn of the millennium. In other words, the much vaunted valuation expansion that took place was based upon flawed expectations. Scary or what?

Before you accuse me of finally throwing in the towel, let me reassure you that, in my opinion, the rise in the stockmarket that took account of lower interest rates and subdued inflation was justified. Whether all the rise was justified is another matter. The problem lies in calculating how much that adjustment should have been. Unfortunately, no one really knows what we are paying for many company shares at present. Calculating the valuation level has become tricky.

We tend to look to the past when we endeavour to rationalise current market behaviour or to extrapolate what might take place in the future. The sideways movement of the Dow Jones Industrial Average between 1967 and 1982 has been mentioned often recently but this is a misleading measure. The headline benchmark for the US is a very narrowly based index and calculated in a way that takes no account of the actual worth of the constituent companies. The S&P 500 index, which is a far better indicator, rose by more than 50 per cent during this period. Hardly a great result for 15 years but a better representation of what actually happened.

The other comparison drawn recently over the current situation in the US is that its economy looks like that of Japan following the initial collapse of its index. Share prices in Japan are still little more than 25 per cent of their value in 1989, so the worry is that the US market has much further to fall. Yet most comparisons between the US and Japan are spurious. Japanese business practices are far less transparent than in the US while there are real demographic problems in the world&#39s second-biggest economy. The US, in contrast, has a relatively high birth rate for a developed country and continues to suck in immigration in a way that can only be positive for economic development.

But we need to return to this problem of calculating the valuation of shares or, more particularly, working out how much profit companies are making. It is not just the problems highlighted by Enron that are leading many analysts to scratch their heads over what they should be putting into their calculations. True, figures are less trusted than before but the reality is that events happen so much faster than used to be the case. Technology is a wonderful thing but it can lead businesses to change direction swiftly and stock-specific risk is now a real problem.

There is, though, nothing new under the sun. I came upon a verse published in a November 1883 edition of Punch which made me think of current conditions. Capel Court still exists – I think. The sentiments expressed are just as valid today as they were then. Perhaps we should take comfort from that.

“It was a weary stockbroker who stood in Capel Court,

That&#39s just outside the Stock Exchange, where brokers most resort,

Quoth he, In speculation there&#39s a most disastrous lull,

And business in the City is indubitably dull.

There&#39s nothing doing in the house in any stocks or shares,

And very silent are the bulls and angry are the bears,

&#39Tis no use dealing with ourselves, endeavouring to best

Each other, when the public won&#39t be tempted to invest.”


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