From the 1990’s to the present: It's 'déjà vu all over again'!

Terence Craig, Chief Investment Officer at Element Investment Managers writes that this quote, attributed to baseball’s Yogi Berra, (a 60’s a New York Yankees baseball player) seems entirely appropriate in our current investing environment.

 We are sometimes criticized when many of the secular (i.e. long-term) trends we research and present on are the same - year in and year out.  However, these are the long-term trends that have shaped and will shape our investment universe in the past and in years to come – they change gradually over time – unlike many investors’ perceptions which are heavily influenced by short-term noise.  We thought it useful to examine a few similarities with the past that look to us like “déjà vu all over again”!

Time magazine covers

•             15 February 1999 – described in a somewhat fawning article as “The Committee to Save the World” – Robert Rubin, Alan Greenspan and Larry Summers.

•             A year later the tech bubble burst, Greenspan cut interest rates to 45 year lows and created an even bigger bubble in housing.

•             28 December 2009 – Federal Reserve Chairman Ben Bernanke is named Person of the year.  Described in a somewhat fawning article as “the mild-mannered man who…prevented an economic catastrophe.” 

•             Time will tell whether Bernanke’s current policies are creating further economic catastrophes or whether there are “no asset bubbles in U.S.” as described by him in December 2009. 

Excessively loose monetary policy

•             The continuation of the “quantitative easing” of low interest rates is exactly the loose monetary policy that steered the global economy into trouble in the first place:

•             Investment in fixed assets was far beyond the level required by the world economy (think Dubai’s building boom).

•             It allowed the less productive parts of investment banks to grow to a huge size and mainly to the benefit of senior employees (and few others).

•             What will happen when the cheap money is no longer available?  Generally cheap money masks those businesses and operations that are uneconomic without it – when the cheap money dries up these businesses will, in all likelihood, fail.

Investment banks are being encouraged to take (huge) risks again

•             Having acknowledged some banks as “too big to fail”, authorities are giving free reign for risk-taking (and the large bonuses that follow), as bankers know that there will be someone willing to bail them out.  Allowing some to fail (e.g. Lehman Brothers) and others to merge, has created fewer, bigger players with a licence to take risk. 

•             The separation of commercial and investment banks in the US was set out in the Glass-Steagal Act of 1933 as a result of the collapse of a large portion of the US commercial banking system. This Act was repealed in 1999 and, over the last decade, this has led ultimately to huge risk-taking by institutions placing depositors’ money at risk. 

Avoiding or repeating the Japanese experience?

•             The damage from Japan’s early 1990s property and banking bust is still visible and regulatory actions to try and avoid Japan’s experience has shaped other governments’ responses to the financial crash. 

•             However, as the Economist points out (Nov 2009) in an article entitled “Same chords, different tune” - “the real strategy in most post-bubble economies is to allow banks to grow their way out of trouble gradually, by making fat profits on the back of free central-bank cash. Many impaired assets remain on their books. The result is a dysfunctional banking system, with credit shrinking, thanks to lack of supply as well as lack of demand.  For years, Japan had the advantage of being the only big country in trouble. Today, more balance-sheets need repair, the prospects for export-led growth are dimmer, and the increases in public debt will be broader.”

Consumer demand distortions

•             Authorities have been trying to stimulate demand by offering consumers incentives that are unsustainable in the long run – e.g. “cash for clunkers” for motor vehicles and housing subsidies for first-time buyers. 

•             The US automakers offered 0% finance after the tech bubble burst in 2000 in order to stimulate demand. This provided a boost to their short-term volumes at the expense of their businesses long-term. 

Bullish vs. bearish sentiment

•             As measured by Investors Intelligence in mid-December 2009 the US bull-to-bear ratio reached 3.13 (i.e. over three times as many bulls as bears).  The last time the ratio was over 3, was in October 2007 when it reached 3.16 (see chart below).

•             This measure is a contrarian indicator – extreme bullishness is normally a good time to sell. 

Global security concerns

•             While no-one will forget 9/11 in 2001 as one of the most significant events in the past decade, we were reminded, in December 2009, that it was not an isolated incident, when a potential bomb blast on a US airplane was foiled 20 minutes before landing in Detroit. 

•             Terror attacks have not disappeared; (rightly or wrongly) wars are being fought in Iraq, Afghanistan and many other countries around the world.  These are issues that influence government policies, government deficits and potentially governments themselves come election time. 

High ratings

•             The SA stockmarket (as measured by its All Share Index) ended the year on a PE of 17.2 – the 6th highest at year-end in the last 50 years and on a dividend yield of 2.2%, the third lowest at year-end in the last 50 years (see year end dividend yield chart below). 

•             This is seldom a great starting point for generating good long-term returns and we would highlight that SA real earnings levels (the “E” in the PE ratio) are close to their 50 year trendline (i.e. the PE is not high owing to an abnormally low “E”). 

•             The last time our market looked this expensive, was at the end of 1999 when the PE was 17.8 (the third highest in the last 50 years) and the dividend yield was 1.9% (the lowest in the last 50 years). 

•             It is worth noting that the subsequent 3 and 4 year returns from the FTSE/JSE All Share Index from the end of 1999 were a rather pedestrian 6.9% and 9.1% p.a., respectively, neither of which beat cash (3 year return of 10.8% p.a. and 4 year of 11.1% p.a.) and we would caution fellow investors not to expect great returns from our stockmarket, going forward. 

Based on our concerns that current central bank policies may be the cause of further investment bubbles, it’s worth recalling another famous quote from Yogi Berra – "It ain't over till it's over" (from 1973 when he was manager of the New York Mets that were way out of the running at the time, but ended up winning their divisional title).

We are cautious about international and local stockmarket levels, long-term, and our portfolios remain positioned accordingly. Recoveries are usually associated with job creation, credit granting and rising sales, all of which remain under pressure, while stock and commodity prices continue to rise. We do understand that the continued availability of cheap money could well push markets even further in the short-term, but from a long-term perspective, the risk appears firmly to the downside. George Soros provided investors with a timely reminder in late 2009 when he cautioned that “…the prevailing mood is far removed from reality.”

As we enter a new decade, it is worth highlighting that all our portfolio managers started their careers well over a decade ago – experience that should be of benefit in what could well prove a tough investment decade ahead.