Precious Metals | Ravenscroft Group | Robin Newbould
18 Jan 21
Weekly update - Should we be fearful? Are others being greedy?
As America gets ready to welcome its 46th president, Robin Newbould, group head of execution & advisory and managing director of Ravenscroft Precious Metals, takes a closer look at the stock markets’ recent performance.
I have, for a wee while, been trying to understand why stock markets, with their inherent (occasional at least) risks of volatility and loss, are hitting all-time highs during the second wave of a global pandemic that has killed off nearly two million people and, more specifically to the matter, decimated economic growth. What gives?
Markets are forward-looking
Yeah, ok … so, what are they seeing that I’m not? Without wishing to revisit the whole global debt pile (estimated at nearly $275 trillion according to the Institute of International Finance https://www.iif.com/Research/Capital-Flows-and-Debt/Global-Debt-Monitor) and the debate about how on earth it gets paid back at any time, if ever, it does feel like investors are currently relying on central bank liquidity to make them money. Improving corporate earnings and recovering economic forecasts (from a pretty low Covid-19-hit base line) look to have been more than taken into account in the case of the S&P500, below:
The stock market has returned more than 164% since the 2007 peak, which is more than 3.8x the growth in corporate sales, and 7.5x more than GDP. Are we ok with that?
It’s all about tech
Ah, so the pandemic has actually improved the fortunes of some companies, and they are the ones driving market returns, right? Well, I guess there’s some merit in this argument. The top 10 companies below (of 500, or thereabouts, don’t forget) do indeed make up over a quarter of the S&P500 index capitalisation and many of the names are technology companies at that.
Tesla Inc aside (don’t get me started), most of the companies have vaguely believable and/ or defensible price to earnings ratios if you squint hard enough, as below, but do we really believe that, for example, Apple Inc is twice the company it was just a year ago?
Created using: https://www.macrotrends.net/
Created using: https://www.macrotrends.net/
Not that Apple is, in any way, out of the norm. In fact, as shown above, it is wholly average in its index at the moment, with all 500 or so companies entertaining an average P/E ratio of over 35x. So that means that the companies making up the other 72.4% (non-tech) holdings of the S&P500, including those whose business is in sectors as exciting as industrials, materials, consumer staples and utilities are all currently trading at an average of 35x earnings or more. That’s slightly less normal, to say the least.
What would Warren do?
As the title of this update is inspired by investment guru Warren Buffett, who once said it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful” and because his Berkshire Hathaway vehicle is in the S&P500 top 10, and because he has more than doubled a substantial investment in Apple, a company which he described in an interview with CNBC in February 2020 as “probably the best business I know in the world*” and because he’s normally quite sensible, I figured that Mr B would be sticking to his knitting. I also guessed that he would be missing out on much of the current stock market excitement. And he most certainly is…
The large cash pile in Berkshire Hathaway will have played its part in this underperformance, which would have been yet more stark without the Apple holding, of course. So is he waiting for a stock market correction? He could be in for a long wait and cannot be immune from the old John Maynard Keynes adage, “the markets can remain irrational longer than you can remain solvent.” If only someone had created a ‘fear and greed’ index for us to consider. Hold on, Tobias Levkovich at Citi Research has only gone and provided us with the chart of his US Panic/ Euphoria index, below. Wow, buyers are partying like it’s 1999 and are even more excitable than they were in tech-bubble 2000!
And so, back to my opening remark, how is it that investors, most of whom are locked in their own homes and incapable of anything like normal life, watching businesses going bust or being propped up by government funding from the magic money tree, are coming to the conclusion that stock markets are worth a punt? Are bank and bond returns so utterly unappealing that equities must be the better bet? Is it a fear of missing out or greater fool theory?
Perhaps I am missing out on reasons to fill my glass half full again. As our own Kevin Boscher said as the new year ticked over:
“The key drivers for markets over the next year or so will likely be the unprecedented monetary and fiscal expansion together with the success of the vaccines. Assuming this goes as expected, 2021 should be another good year for equities and other risk assets.”