The Economist - USA (2021-01-30)

The EconomistJanuary 30th 2021 Finance & economics 61

2

Buttonwood Time warp

CAPE-ability

UnitedStates,cyclicallyadjustedprice-earningsratio*

Source:RobertShiller

*Basedonaverageinflation-adjusted

earningsfromprevioustenyears

50

40

30

20

0

10

2120008060402019001881

H

ere is asage piece of investment

advice you might not usually find in

any tip-sheet, newsletter or “thoughtful”

weekly column on capital markets. It

comes from Will Rogers, a popular enter-

tainer and wit of interwar America, via

the writings of Paul Samuelson, a Nobel

prizewinning economist and wit of

post-war America. Are you ready? Here it

is. You should buy stocks when they are

going to go up. When they are going to go

down, you should sell them.

Nice work if you can get it, quipped

Samuelson. It is a shame only a few can.

Yet the idea of timing the market—all

ups, no downs—remains a seductive

one. Anyone who invests in equities has

at one time or another fancied they can

sell at the top and buy again at the bot-

tom, thus enjoying the return from

stocks while avoiding the risks. It seems

simple. If stocks are dear and investors

look heedless, you should get out of the

market. When it falls back, as it surely

must, fill your boots.

There is a lot of this thinking around

just now. The cyclically adjusted price-

earnings (cape) ratio, a measure of value

constructed by Robert Shiller of Yale

University, has rarely been higher. The

combination of social media and low-

cost trading apps aimed at small in-

vestors is behind a lot of herding into

faddish stocks, a signifier of toppy mar-

kets. In such circumstances it is tempt-

ing to try to outwit the herd. But market

timing is harder than it looks. Few have

the skill, temperament or the focus to do

it profitably.

Stock prices are noisy. The axiom

used to be they are a random walk: their

current levels tell us nothing about

where they are going. A less purist view

has since emerged. This says the earn-

ings yield—the inverse of the cape—is a

decent guide to the expected returns on

equities in the longer run. Put simply, high

stock prices now mean lower returns in

future. At today’s cape, expected returns

are well below the long-run average, just as

they were in the late 1920s and the late

1990s (see chart).

The sharp-eyed will notice that when-

ever stock prices have gone up a lot faster

than earnings, they tend to fall back again.

But would-be market timers could not

have known precisely when to sell. It is

never obvious that the capeis close to a

peak or trough. Studies of timing guided

by valuation metrics such as the cape

show disappointing results compared

with just buying and holding stocks for the

duration. A big problem is selling too early.

As Samuelson, who wrote a lot about the

perils of timing, once put it: “Anything can

be carried on to twice where it has already

reached.” When the market does crater, it

is not so easy to act. It takes nerve to buy

when everyone is selling. Delay seems

wise. Prices could always fall again. The

fate of many a market-timer is to buy

stocks back at higher prices than those at

which they sold.

Despite today’s low expected returns,

shares still have some appeal, because of

the paucity of returns on offer in other

asset markets. In the late 1990s, when the

capesoared above 40, the yield on in-

flation-protected Treasuries was close to

4%. Today it is -1% on the ten-year bond.

If low real rates are the main prop for

share prices, then any attempt to time

the stockmarket is in essence a bet on the

bond market—and, in turn, on how

inflation evolves, and how central banks

react to it. Good luck with getting those

calls right. The forces behind the de-

cades-long decline in real interest rates

and quiescent inflation are not well

understood even by people who have

spent a lot of time thinking about them.

It is hard for most investors to make

judgments about whether, when and

how quickly these secular trends will go

into reverse. Yes, there is something

screwy about negative real bond yields.

In America they are a novelty. But in

Europe and Japan they have lasted for far

longer than many people thought pos-

sible. Agnosticism about their future

path is probably the best policy.

It would be lovely to have ups without

downs. But investment rewards general-

ly come with risks. The advice from

market-timing sceptics like Samuelson

is of the mom-and-apple-pie kind. Sell

down your stockholdings to the sleeping

point, where you can rest easy at night.

Spread your bets widely across stocks

and geographies—stockmarkets outside

America have lower caperatios and

higher expected returns. And remember,

timing is a snare. If there were reliable

trading signals, everyone would follow

them. And then there would be no one to

sell to at the top and no one to buy from

at the bottom.

Markets are frothy—but beware the siren call of market timing

of cinemas, and Nokia and Blackberry,

which once made popular mobile phones,

have also spiked.

In many ways the furore seems almost

as remarkable as the move itself. For the

shorts that lost their shirts the spike in

GameStop is hugely important. But most

investors’ portfolios are probably unaffect-

ed by the price action. Instead the reac-

tion—a wave of bafflement, even panic,

that has washed over Wall Street and drawn

in those running the country—speaks to a

larger disquiet about American stocks.

For months investors have fretted about

a potential stockmarket bubble, their con-

cerns reflected in the fat valuations of tech

stocks and the dizzying heights to which

shares in Tesla, an electric-vehicle maker,

have soared. The exuberance displayed by

retail investors is yet another reason to fret.

In an op-ed for Bloomberg, Mohamed El-

Erian, the former boss of pimco, a bond

fund, warned that the GameStop frenzy is a

prelude to possible “large-scale financial

volatility and market dysfunction”. Mr

Powell was calmer, noting that financial-

stability vulnerabilities overall were mod-

erate. But stocks were jittery on January

27th. The s&p500, an index of American

shares, fell by 2.6%.

Jumpy professional investors will now

have to keep one eye on the mob—and the

other on the more conventional risks of an

inflation scare or faltering corporate earn-

ings. Apple fared well in 2020, helped by

pandemic spending on electronics (see

Business section). But high supply-chain

costs dented profits at Tesla and Facebook

warned of headwinds to its ad business.

Slowing profits from the giants of Ameri-

ca’s stockmarket would really give inves-

tors something to panic about. 7