The past 10 years saw 9/11, wars in Iraq and Afghanistan, a tsunami, the bursting of one stock market bubble at the beginning and a financial crisis at the end. It was one of the rarest decades in which equities gave a negative return.
It has also been a period of US decline, exemplified in the closing fortnight of 2009 at Copenhagen when the US and the West were humiliated and the President of Sudan, in cahoots with China, likening US policy to the Holocaust.
In some ways the position of the US is reminiscent of 1979-80 when I was based in New York. The city was nearly bankrupt, interest rates and inflation were in the mid-teens, the Carter presidency was ending in the ignominy of hostages held in the Tehran embassy and helicopters crashing in the desert. At that time Americans looked enviously on every bookstall at the masses of books proclaiming the supremacy of the Japanese way of doing things. President Reagan promised to make America walk tall again and did. In fact this was a marvellous time to invest.
The level of government debt now and the likelihood of higher taxation and consumer deleveraging, clouds prospects. It is hard to see the way out. But those who invested in around 1981 did so not because they were enraptured by the sighting of that buxom lady Miss Rosy Scenario but because they saw valuations which implied more trouble than there might actually turn out to be.
If looking for recovery, especially focused more on stock markets than on economies, one of the best places to start is Japan. A recent economic review about Japan was entitled “Stronger governance should resolve crisis.” Wings should enable pigs to fly. But the crisis of the past two years, on top of the malaise of the past 20 years has pushed corporations to reduce cross-shareholdings, costs and unprofitable activities, and to pay a little more attention to shareholders, even if progress is frustratingly slow. Valuations in Japan are the most attractive in working memory. In 1989, when the Japanese stock market peaked, it accounted for 45% of world stock market capitalisation; now it is 7%.
The US has been good in the past at bouncing back and it would be dangerous to assume it won’t do so this time. One reason for relative optimism about the US economy in the short term is that the level of inventories is so low. From peak to trough, real inventories dropped by nearly 9%, more than twice as much as in the recession in 1982 and several times as much as in 1974. This is not all that surprising since we can all recall how everything seemed to stop in October 2008. Company spending was curtailed, people were laid off, working capital conserved. After a fierce recession, a sharpish recovery in growth is more to be expected than not. In economics there is even a rule with a name for this rather ordinary principle, the Zarnovitz Rule: “Deep recessions are almost always followed by steep recoveries.”
Some of the gloom about the US could lift and what goes for the US usually goes for Western Europe, where, in Germany particularly, an industrial recovery seems underway. If not too gloomy about the US and Western economies then it is possible to be not too gloomy about Western stock markets. Valuations may not be remarkably cheap – though in Europe they are - but they are not unreasonably high. And a 10 year period in which returns are negative is a great rarity, usually followed by a period when returns are more than satisfactory (Japan from 1990 to 2009 being an exception to this).
The way in which valuations have changed over the past 10 years is demonstrated in the figures below which show the price-earnings ratios at the end of 1999 and 2009 of the companies in the Morgan Stanley Capital International World Index with market capitalisations larger than $140bn as of December 1999.
The 2009 figures are higher than they might be, because the earnings on which the ratios are based are those of the last (published) 12 months and these have been depressed during the recession. So the comparison is even more favourable than it appears.
Markets fell sharply in 2008. Although the rise since March 2009 has been formidable, the world index is still some 22% below its level at the start of 2008. During 2009, Asia, ex-Japan, has been the outstanding performer. It is not too late to say, in terms of investment in companies if not assuredly in economic outlook:
“And not by eastern windows only
When daylight comes, comes in the light.
In front, the sun climbs slow, how slowly, But westward, look, the land is bright!”
A Google of the author of this, A. H. Clough, produces something else apt
on which to conclude with hopes for
a happy 2010:
“The world is very odd we see,
We do not comprehend it;
But in one fact we all agree,
God won’t, and we can’t, mend it.”
