A mar­ket bloated like an ele­phant?

Finweek English Edition - - MONEY -

Fol­low­ing an ac­tion-packed week in in­vest­ment mar­kets, I would like to quote a few l i nes f rom John God­frey Saxe’s fa­mous 19th- cen­tury poem, “The Blind Men and the Ele­phant”.

IT STARTS WITH: earn­ings (P/E) ra­tios may ap­pear to be high, we have to con­sider the S& P500 In­dex’s cur­rent P/E of 20.8 is rel­a­tively low com­pared to the 20-year av­er­age of 27 be­tween 1990 and 2010. Of course, many parts of this ‘ele­phant’ can be sin­gled out to sup­port claims about why the ele­phant isn’t any­thing like an ele­phant at all. SO WHAT IS THE RIGHT AN­SWER? HOW DO I GO ABOUT SEE­ING THE BIG PIC­TURE WITH­OUT CON­SULT­ING A CRYS­TAL BALL? In my opin­ion, War­ren Buf­fett pro­vided us with t he per­fect tool when he de­scribed the to­tal mar­ket cap­i­tal­i­sa­tion rel­a­tive to the to­tal GDP as “prob­a­bly t he best si ngle mea­sure of where val­u­a­tions stand at any given mo­ment”.

As wit h a ny ot her r at i o a nd i n v e s t ment tool, t h e ma r k e t cap­i­tal­i­sa­tion-to-GDP ra­tio is based on his­tor­i­cal data and should not be seen as a pre­dic­tion of fu­ture per­for­mance. How­ever, it may be t he best tool to de­ter­mine whether this is a real ele­phant, be­cause it in­volves look­ing at the to­tal value of share prices rel­a­tive to the mon­e­tary value of all goods and ser­vices de­liv­ered within a given coun­try’s bor­ders. It is the com­plete pic­ture.

This ra­tio can only be determined on a quar­terly ba­sis ( be­cause GDP f ig­ures are only cal­cu­lated quar­terly) and it pro­vides a view of what re­ally hap­pened in the econ­omy in the last 12 months. Be warned, how­ever, that this ra­tio should not be used for short-term rec­om­men­da­tions.

When we take a look back, we see that to­tal cap­i­tal­i­sa­tion passed GDP three times in the last three decades. The in­stances in both 1997 and 2007 were not only fol­lowed by volatile and stormy mar­ket con­di­tions, but also showed up in our lo­cal share mar­ket, fol­lowed by no growth in shares for more than two years.

So what ex­actly makes the third t i me so dif­fer­ent? This r at i o has been at more than 1 for the past t wo years. The short an­swer is that due to the US Fed­eral Re­serve’s gen­er­ous in­ter­est rate pol­icy, prices have been pushed up ar­ti­fi­cially to a large ex­tent, leav­ing things at ‘ bub­bling’ lev­els. My ques­tion is, what will hap­pen when this pol­icy changes?

Whether wrong or r i ght, t hose ‘ele­phant touch­ers’ are con­vinced we are f in­d­ing our­selves at high mar­ket lev­els world­wide, so en­sure your port­fo­lio is free of any over­weight po­si­tions.

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