Andrew Smithers’ view on economic outlook
Andrew Smithers is an economic commentator whose book ‘Valuing Wall Street‘ I highly recommend. He is another market economist who shares my view that a ‘Buy and Hold’ Strategy is not necessarily the best. But he also has an economic commentary in FT Alphaville which suggests he is expecting recession. The most interesting part of his commentary is that he believes corporate balance sheets are more stressed than they appear and that the recession will bring trouble to corporates and their bank lenders
Economic commentator Andrew Smithers has a dim view of growth prospects for the eurozone, UK and Japan but overall, he takes an unusually mild approach in his latest world market report to clients.
In short, says Smithers:
• The unexpected surge in worldwide inflation shows that output has been running well above its equilibrium level. Growth must therefore slow to well below trend rates if inflation is to fall back.
• Below trend growth will mean lower profits in terms of national accounts. Larger falls are likely in company accounts, as the profits booked by the change from historic cost to current value accounting turn to losses.
• The change has also given a “misleadingly optimistic view” of company balance sheets, he says.
The misunderstood problem of corporate balance sheets will cause problems for banks and other lenders, and lead to higher equity supply as banks become increasingly unwilling and unable to extend credit.
• The U.S. was the first major economy to suffer from weak domestic demand, but this has now become widespread. The fall in domestic U.S. corporate profits has so far been partly offset by rising profits from foreign subsidiaries. With weak demand now becoming general and a stronger dollar, argues Smithers, U.S. foreign subsidiaries will see falling profits in dollar terms in 2009, thus accentuating, rather than limiting, the fall in U.S. domestic profits.
• There are three main possible outcomes for the key economies: (i) Recovery to trend growth or above, beginning in 2009. (ii) Below trend growth, with or without mild recession, over the next 18 months or more. (iii) A major recession in terms of either depth or duration.
• Early recovery would lead to a sharp rise in inflationary expectations which have, so far, remained surprisingly and happily constrained. Fortunately, improved demand seems increasingly unlikely with economic weakness appearing in all major economies.
The best possible outcome, which is weak growth or mild recession, continues to look the most likely as well as the most desirable outcome. A major recession is the next most likely but, if demand deteriorates much more, the response should be some fiscal and monetary stimuli.
• In conclusion, then: Bonds are extremely overpriced, though likely to be supported by economic weakness. Shares are both overpriced and likely to be hurt by falling profits. Cash is better than either.
This theme is in line with my recent Chart of the day post about avoiding ‘Buy and Hold.’ Given the alternatives, one might consider staying on the sidelines in cash while the recession unfolds. His comments also highlight an additional worry for banks as writedowns continue to mount.
As for Smithers’ book, it seems to be out of print in the U.S. but it is available in the UK. Here is Amazon’s Book Review:
There’s a joke going around the investment community: “You know the definition of a long-term investment? It’s a short-term investment gone bad.” In this absolutely delightful, easy-to-read book, authors Andrew Smithers and Stephen Wright argue downright investment heresy: maybe long-term, buy-and-hold strategy is not the most winning strategy available to investors today. And while they do not argue that in-and-out day trading is the answer, their suggestion is for investors to use “Tobin’s q” to determine when to be in or out of the market. Tobin’s q was devised by James Tobin in 1969, for which he won the Nobel Prize in economics. The “q” is a measure of stock market value to the actual value of the underlying assets of the firm. In times of high q, investors should sit out of the market, whereas in times of low q, investors should wade back in.
According to the authors, “the benefits of long-term equity investment have been dangerously oversold by harping on long-term returns, while failing to point out that this long-term is simply too long for most investors”. Indeed, their aim is not to tell you how to make money, but instead to show you how to avoid losing it. They claim that today’s market q value is so dangerously high that preserving wealth–and not trying to find the next hot shot Internet penny share–is paramount.
Valuing Wall Street is a thought-provoking work which compares the use of price/earnings ratios, dividend growth models and dividend yield models for their predictive power in valuing markets. The authors, who have one foot in the real world (Smithers run a market consultancy firm) and one in the academic camp (Wright is a lecturer at Cambridge), dismiss stockbrokers’ “Stocks are wonderful” mantra in an amusing fashion. Any serious investor, and especially those nearing retirement, would do well to read this book. –Bruce McWilliams