New Zealand Herald, 28 February 2012
Nathan Field, Senior Equity Analyst at Gareth Morgan Investments
When stock markets fall, the media is quick to show images of brokers slumped over their desks with their heads in their hands, or graphs of jagged red arrows pointing to an abyss, just to emphasise the ruin and despair being wrought upon the world.
However, when markets rise, we never see brokers high-fiving and back-slapping around the office, or graphs with big green arrows pointing to the moon. A rally might be written up in the business pages, but it's rarely front page news.
This is hardly surprising. No one wants to see a photo of a grinning broker while they're eating their cornflakes. But as a consequence, the man on the street is often unaware when markets are in good cheer.
Global markets are currently enjoying a strong run. Since the recent lows in September 2011, both the MSCI All Country index and the S&P 500 have risen more than 20 per cent in US dollars. For local investors, the surging NZ dollar has tempered some of those gains. But regardless of where you are in the world, the rally in equity markets has received minimal coverage.
Financial headlines remain resoundingly negative. The mess in Greece. Bleak prospects for wider European growth. The flimsy US recovery. These facts are generally accepted by bulls and bears alike. So given this backdrop, how can stock markets be rallying? Is it just because central banks are flooding the market with cash?
Well, the liquidity boost certainly isn't hurting. But there are other sound reasons why stocks have been in rally mode.
Firstly, equity markets are forward looking. They're not always right, but they are trying to predict trading conditions 9-12 months down the track, not mirror today's headlines. That's why the recent improvement in US economic data, however slight, has had such a marked impact on share prices. If investors wait until the global economy is firing on all cylinders, shares will be a lot more expensive, and the smart money will have moved on.
Secondly, sharemarkets are made up of companies, not economies. The problems facing Europe haven't stopped people buying iPhones, or swiping their Visa cards, or taking Nurofen to soothe their hangovers. Sure, sluggish economies can dampen earnings in the short term, but if the companies you're buying have healthy balance sheets, and produce goods or services that people want, and are making decent money in a crappy environment, you're less fussed about fluctuations in the economic cycle.
Finally, and this is the biggie, valuations really do matter. Even after the rally, global equities are trading on a forward earnings multiple of less than 12 times, the lower end of the five-year average range of 11-14 times. Yes, those valuations will mean nothing if the world collapses, but banking on the sun rising tomorrow has proven to be a smart bet in the past. The relative valuation argument is even more compelling. Plenty of US blue chips trade on free cash flow yields of 5-10 per cent, while US Treasuries yield less than 2 per cent.
The turn in equity markets is getting under the skin of the world's permabears, a group of surly chin-scratchers who believe that the global economy is doomed, and equities are always a rotten investment. Oddly enough, they manage to pick every market crash and completely miss every rally. The permabears will have their day in the sun again, but at the moment, they're getting burned. And dismissing a 20 per cent gain as a sucker's rally sounds like a case of sour grapes.
If you're one of the suckers who've bought into the rally, don't worry, you're in good company. Warren Buffett, arguably the greatest investor of all time, went on a US$20 billion buying spree in the September 2011 quarter, right when the permabears were screaming that the sky was falling in. Today, Buffett is reaping the rewards of the fear they spread.
Of course, not even Buffett is infallible. He's never professed to be an expert at timing markets, and there are plenty of bumps in the road ahead. But when Buffett sees value in stocks, given his long-term track record, write him off at your peril.
The lesson to be learned is that it's possible to have a cautious outlook on the world and still be bullish on equities. The fact Buffett has been buying stocks doesn't mean he thinks Europe's problems are overstated, or that the global economy is out of the woods. He just knows a bargain when he sees one.
Any opinions expressed in this column are Nathan Field's personal views. These opinions are general in nature and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. Readers should seek independent financial advice before making an investment decision.