John Authers

Just a brief post to pass on a thing of beauty. Critics of market-capitalisation weighting for indices always complain that you are in effect always buying the companies that are most overvalued. There is a lot of truth in this.

In the chart, Ned Davis Research create an index with just one stock in it: the biggest by market value at the time. As soon as a company is overtaken it is replaced in the index of one by the new leader. Trivia devotees may like to know that there have only been nine such stocks in the last four decades: Apple; AT&T (though not in its present incarnation); Altria (once known as Philip Morris); Cisco Systems (beneficiary or victim of the most absurd episode of equity overvaluation in history); ExxonMobil; General Electric; IBM; Microsoft; and Wal-Mart. All are undeniably great companies that at some point since 1972 the market thought to be worth more than any other. Here is how these companies performed compared to the S&P 500, starting in 1972: Read more

John Authers

Is there really any way that financial engineering could cure cancer? That was the argument that MIT’s great Andrew Lo made during a visit to London last week, and being an entrepreneurial finance professor he is now trying to bang the drum to get his idea off the ground. If he has his way, he will end up creating a $30bn cancer “super-fund” that will invest in 150 different anti-cancer projects.

It is if nothing else a fascinating idea. I wrote a Monday column on it, while the Economist’s Buttonwood (in real life a former Long View writer) blogged on it. Both of us came out broadly in favour. My video interview with Professor Lo appears here:


Andrew Lo on Cancer


Virtually all of us as humans would like it to work. Does it actually stand a chance? More on that after the break. Read more

John Authers

Today’s Note video is with the MIT economist Bob Merton – famous both for winning a Nobel memorial prize for his part in drawing up the Black-Scholes options-pricing theory, and for his part at Long-Term Capital Management, the hedge fund that nearly brought down the world credit markets when it came to grief just a year later in 1998.

Prof Merton was talking about a profoundly important subject. We know that the world’s credit markets were dangerously interconnected entering the crisis. He and a team at MIT are now working out how to measure that interconnectedness, in the hopes that by understanding the phenomenon we might be able to get to grips with it better this time. The alarming finding is that credit is even more interconnected now than it was before the crisis. The video appears here:




As we tried to cover a lot of ground in under five minutes, some extra detail on how Merton produced his findings might be useful – see after the break. Read more

John Authers

Yet again, it is time to rain on the parade of the many people who are excited by the new high set on Tuesday by the Dow Jones Industrial Average. The rally in US stocks is impressive, however you measure it. But the Dow remains a fatally flawed index, and there is no reason why anyone should pay any attention to it. I said this as the Dow hit landmarks back in 2006 and 2007. Here goes again.

As an index of only 30 stocks, the Dow is not broadly diversified and is not representative of the US stock market as a whole (the S&P 500, by far the world’s most widely followed index, is more important for that purpose). Its stocks are not uniformly large enough to qualify as a “mega-cap” index (try the Russell Top 50 instead). Neither are they sufficiently dominated by industrials (despite the name) to qualify as an industrial index (the S&P 500 industrials sub-index might work better for that). Read more

John Authers

Today sees the publication of Credit Suisse’s annual Global Investment Returns Yearbook, a mammoth piece of research into global long-run returns overseen by the London Business School academics Elroy Dimson, Paul Marsh and Mike Staunton. It is an invaluable resource, and this blog is likely to mine its contents for some days to come.

Revisions for this year help ram home one quick and spectacular lesson from history. Baron Nathan Rothschild is widely believed (wrongly, according to historian Niall Ferguson) to have said that you should “buy when there’s blood in the streets”.

Much of the time this advice works. Buying into Japan or Germany after the second world war would have worked out extremely well, and the greatest buying opportunities almost by definition come when it seems almost mad to buy.

But the aphorism is not infallible. This year, the academics tried to address their concern that their global stock market index suffered from “survivorship bias”. So they have recalculated them including three new countries that were not previously covered in their attempts to calculated the global equity risk premium: China, Russia and Austria. Adding these nations hugely changes the perception of long-term risk.

Let’s start in Russia. Any bold contrarians who decided in the late 19th century to bet on Tsarist Russia to outperform the US for the long-term, and held on even during the great political unrest of the attempted revolution of 1905, would for a long time have looked very clever.

The chart compares the St Petersburg stock exchange’s composite index performance with that of New York. After 1917, of course, the value of any equity investment in Russia was wiped out. This might appear to be an exceptional example. But it is not. China also had a revolution that led to the closing down of its stock market (and of capitalism for a while), and that happened within living memory. On the eve of the second world war, China’s returns looked very healthy. With the arrival of Mao, shares went to zero (and international investors have had a rough ride even since Chinese stock markets reopened).

Using the MSCI China index, covering stocks available to international investors, those who bought in 1993 have actually lost money. But Chinese stock markets have been recovering recently. And, deliciously for those who like historical ironies, the Shanghai Composite, the main domestic index, bottomed last year at 1949, the year of the revolution. Read more

John Authers

Has the Great Rotation already started? A couple of startling data points from the last month, covering treasury yields and flows into equity funds, certainly suggest so. But the picture is maddeningly unclear under closer examination.

First, there is the treasury bond market, as discussed in last week’s video with Mike Mackenzie, before 10-year yields had risen above 2 per cent (they’re back below today). Significant rises in yields would be an obvious sign of a rotation. You can see that video, and Mike’s emphatic argument that if the equity rally makes any sense at all then the rotation out of bonds must be coming, here:

Note that even with the brief move above 2 per cent, there is still a way to go before the inexorable downward trend in yields that has now lasted more than a quarter of a century is breached.

The other obvious data to look at concerns flows into equity mutual funds and exchange-traded funds. Until very recently, the trend to pull money from equities and transfer it to stocks has continued unabated. Stephane Deo of UBS discussed this with Ralph Atkins in the Note video available here:

Again there are signs of change, but not enough to make the call that the “Great Rotation” has already begun. Most startlingly, TrimTabs, which can publish flow data quickly because it uses algorithms to derive estimated flows from funds’ performance, found that inflows to all equity mutual funds and ETFs this month have already topped $55bn. That beats the previous monthly record, set ominously in February 2000 on the eve of the dotcom crash. Read more

John Authers

Active investment still has some active defenders, at least in the UK, to judge by the reaction to a recent Long View on the subject. And digging into the reasons for active funds’ persistent problems, it is easy to see why. Despite the claims of the Efficient Market Hypothesis (EMH) that it is impossible to beat the market other than by luck, it appears that an impressive number of managers do achieve the feat.

The problem is that they do not manage to beat the index by enough to be able to pay themselves and still pass on a decent performance to their clients. In other words, to quote Jack Bogle, the founder of Vanguard and the spiritual father of index investing, the case for passive investing rests on the CMH (Cost Matters Hypothesis), not the EMH. Read more

John Authers

Hedge fund returns should not be compared directly to equity benchmarks. Hedge fund marketers will always say this, and with some reason: hedge fund strategies have a different risk-return profile from equities. Many allocate a lot of money to “short” positions, betting against the market. So it is not necessarily that surprising or damning when equity hedge funds suffer a very bad year compared to the index, as happened last year. That was a big part of my discussion with Hedge Fund Research’s Ken Heinz in the latest Note video:

But it is interesting to look at how hedge fund investors seem to have behaved. And in aggregate, they look a lot like classic retail mutual fund investors, chasing performance and piling in after a good run. Inflows to hedge funds last year were slightly lower than they were in 1993, according to HFR (and obviously far smaller in percentage terms). The great boost to hedge funds’ assets came in the years after the dotcom crash of 2000, when many funds managed to rise. Read more

John Authers

Goldman Sachs’ strategists are currently roaming Europe on their annual Global Strategy roadshow. As nobody can lightly ignore what Goldman is saying, the themes emerging from the London event were interesting.

Of particular concern are the prospects for corporate earnings; Japan; and the hope that 2013 will at last be the year for a “great rotation” out of bonds and into stocks.

On earnings, David Kostin, their US equity strategist, explains their view in the video below. In a nutshell, margins are high, but without a recession (which nobody expects) there is no need for a sharp reversion to the mean. Instead, forces such as shale gas will help profitability, but there will be little increase in margins as in many sectors they are already at historical highs. So margins stay at their plateau, and earnings rise gently thanks to the gentle recovery of the economy.

On Japan, bullishness is what might almost be called a “consensus contrarian” call. Many people are talking bullishly about Japan, despite its decades of under-performance. So many, indeed, that it is hard to call this call contrarian any more. Read more

John Authers

How is the US election affecting markets? Well, it seems that investors expect re-election for President Barack Obama, and their degree of confidence about this has increased remarkably in the last week. Mitt Romney’s bad stretch, as far as the markets are concerned, seems to have finished him off. That is the subject of today’s Note video, with Gideon Rachman.

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John Authers

The S&P 500 has almost completed its round trip, and done so remarkably quickly. It only has about 5 per cent to go before it reaches its all-time high from 2007. Today’s video guest, the ever-interesting David Ranson, suggests that this was predictable, because asset markets reliably follow an exponential recovery path after a big fall.

Certainly, that pattern fits this recovery remarkably well: Read more

John Authers

As predicted, there is more to say about the London housing market. It is widely known that the buying pressure on prime London properties is coming from overseas. The eurozone crisis and the creation of fortunes by the commodities boom have helped push lots of money into the nicer neighbourhoods of central and west London.

But I had not previously grasped that foreign demand was also driving segments of the market below the true “prime” postcodes, and that that foreign demand is not primarily European or Middle Eastern but rather from Hong Kong, Singapore and Malaysia. That is the strong message from this extraordinary chart from Jones Lang LaSalle, shared by Ed Hammond, our property correspondent, in the latest Note video: Read more

John Authers

Today’s Note video is on Frontier Markets. In theory, they should be exciting, offering the chance of real upside for the bold that Emerging Markets once did. In practice, FM equities have been mediocre over the last few years, while spreads on FM debt has tightened so sharply as to raise questions about how discriminating the buyers have been. The video, with Robin Wigglesworth, is here:

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John Authers

Is it more accurate to refer to QE∞ instead of QE3? Unlike the previous doses of US QE, this campaign of asset purchases has no official limit, and will carry on until the unemployment rate has improved “substantially” – a word that the Federal Reserve can define, and redefine, as it sees fit over the years ahead.

I have already argued that this should be regarded as stunningly aggressive. In the latest Note video, Gavyn Davies, a fellow FT blogger, agrees. The key point, he suggests, is that over the last year the Fed’s reaction function has changed. It is not just that the employment situation has worsened but also that, for whatever reason, it has decided to give the full employment part of its mandate greater emphasis than before. There are plenty of possible reasons for this, which we discuss in the video: Read more

John Authers

What should we believe about China? That is the topic of today’s Note video with James Kynge, principal of the FT’s China research service, China Confidential. Uncertainty currently roils both China’s economics and its politics.

Plainly it is hard to spin the abrupt and unexplained disappearance of prospective premier Xi Jinping in any way that is positive. He is supposedly about to become the world’s second most powerful man – we still do not even know the date for the Congress that will approve that appointment, but it is due next month – and yet he has suddenly disappeared from public life. The news overnight (after we recorded the video) that he was named in a list of dignitaries expressing condolences to the family of a deceased , removes some of the more alarming explanations for his absence, but speculation about his health continues. The continued refusal to provide any official explanation for his absence is a classic example of Chinese opacity. Read more

John Authers

Judging by the response to my Monday column, a lot of people are interested in central London property. As that has been followed by news that a London house is on sale with an asking price of more than £100m, in Hampstead, it’s easy to see why. One of many requests was for more granular data.

Thankfully, I can oblige. London, obviously, cannot and should not be treated as one market. In particular, “prime” central London, because of its appeal to international buyers, seems to follow very different dynamics from the rest of the capital. That appeal varies according to area. The following chart, provided by Hometrack, plots every Greater London broad postcode on two scales – their performance since the overall market first peaked five years ago, and their actual price. Read more

John Authers

Marc Chandler of Brown Brothers Harriman is always  interesting. His take on the QE3 debate, ahead of the FOMC’s next decision, might startle many in the US: the US economy is in an enviable position – why is there any need for dramatic new exceptional measures?

Evidently many Americans do not feel as though they are much to be envied, and unemployment has dragged on at levels that are politically unacceptable. But America’s post-Lehman economic trajectory, with the recovery looking ever more firmly founded, should certainly be the envy of western Europe and Japan. Read more

John Authers

Whether it likes it or not, the Federal Reserve has been pulled into the political thickets. The demand is for it to “do something”. Whatever it does at its meeting this week will have  political ramifications, and you do not need to belong to the Ron Paul faction to question whether further QE of any kind is necessary at this stage.

As James Mackintosh pointed out in the Short View, inflation expectations and asset prices are both rising now, rather than falling as they were before QE1 and QE2. This Fed has a philosophical aversion to deflation, but there appears to be no imminent danger of that. Read more

John Authers

Mario Draghi has at the very least pulled off a great coup of expectations management. On Thursday he said exactly what everyone expected him to say. Markets had already rallied in hope for more than a month ahead of his announcement. This might usually be the cue for a sell-off, but instead the euro held steady, while peripheral bond and stock markets went to the races.

Spain’s 10-year yield is now below 6 per cent, while the buying opportunity when this risk-on wave started now looks to have been immense. Spanish shares (as measured by the Ibex) are up by a third in the two months, while Eurozone bank stocks (as measured by the FTSE Eurofirst index) have gained more than 50 per cent. I discussed all of this with Jamie Chisholm in the first of the new series of Authers’ Notes:

The larger questions are whether this can continue, and if there is any way to time the risk-on and risk-off waves. Read more

John Authers

There are interesting arguments over whether the US residential housing bubble has really finished correcting, as I argued in a column earlier this week. But if it hasn’t, then the outlook for property in theUK, and most especially London, is alarming.

Of all the local property bubbles, Miami’s was the most extreme. Let’s look at it in comparison with London. For the US, we use the S&P Case-Shiller data, which are now widely followed. For the UK we use data from the LSL Property Services/Acadametrics indices, which is deliberately setting out to map the UK property market in the same way that Case-Shiller maps the US. Handily, both are set so that the beginning of 2000 equals 100.

So Miami plainly had all the symptoms of a bubble, with prices leaving for orbit in a way that they never did in London. But London’s inexorable rise looks extraordinary by comparison. Read more