NEW YORK (Reuters Breakingviews) - “Stock prices have reached what looks like a permanently high plateau.” So, famously, said economist Irving Fisher about two weeks before the 1929 equity market crash. In “The Long Good Buy,” Peter Oppenheimer, Goldman Sachs’ chief global equity strategist, gives investors tools to identify the types of financial cycles Fisher failed to identify. Though written before the Covid-19 crisis, the book can help make sense of the magical thinking driving today’s head-scratching market and the gyrations in asset totals at giant fund manager BlackRock, which reported its second-quarter earnings on Friday.
Historical perspective is Oppenheimer’s strong suit. While his book mostly focuses on the last 50 years, he also reaches further back. He not only covers the U.S. railway frenzy of the 1870s, but also Great Britain’s eighteenth-century canal boom. He breaks down marquee market blowups – like the 1929 crash and the 2007-2009 financial crisis – but also discusses events that younger investors might be less familiar with, like the United Kingdom’s ignominious exit from the European exchange rate mechanism in 1992.
This all gives him credibility to make a more nuanced argument than is often laid out in investment books. Sure, markets are defined by cycles, he says, but these are a complex web of economics, human emotions and policy – not a financial version of a sine wave. He describes multiple types of bull and bear markets, including cyclical, event-driven, structural and even non-trending.
To make matters even more complicated, Oppenheimer argues that technological, regulatory and other changes – like the internet, low interest rates and globalization – can affect the shape and duration of cycles. This is why identifying inflection points isn’t as simple as, say, pointing to an inverted yield curve and hitting “sell.” Especially because mini cycles occur even as longer trends persist.
So how does this help make sense of this year’s Covid-19 market swings? At first glance, the S&P 500 Index’s almost 35% plunge to a late-March low seems like an event-driven bear market. Unlike cyclical bear markets, which are normally the result of declining profit expectations, rising inflation and interest-rate and recession fears, event-driven plunges are typically caused by exogenous shocks, emerge amid low inflation and are short-lived.
Though the recent steep dip seems unbelievably brief, the facts broadly fit. Take BlackRock. Larry Fink’s juggernaut just posted a solid second quarter. Its earnings increased 21% from the same period last year. That’s a big improvement over last quarter’s 23% drop. More importantly, the company’s total assets under management rose back above $7 trillion after tumbling 13% to $6.5 trillion during the first quarter. Fund inflows helped, but so did Federal Reserve liquidity injections, which boosted valuations across the board.
Yet a closer look suggests that what may be happening – with the recent market rebound – is the continuation of a longer cycle. Oppenheimer points out that after 2009 the U.S. economy grew at a weaker pace compared to other post-1950 recoveries, yet the equity market performed well above average. It eclipsed its previous peak within four years. In comparison, after the crises that began in the U.S. in 1929 and Japan in the 1990s, equity prices were languishing under 50% of their peak even a decade later.
So the severe disconnect investors are currently experiencing between the real and financial economies is not a new phenomenon. It actually may be fairly predictable. After all, many of the forces driving equity prices in the past decade – such as ultra-low rates, aggressive central bank bond buying and the outperformance of technology stocks – have only accelerated in the most recent crisis.
Should this be worrying for those investing with BlackRock or anyone else? Probably, yes. Oppenheimer wasn’t ringing alarm bells before the crisis, but what he does say is that valuations matter, despite structural changes. Economic history shows that investors get in trouble when they convince themselves that absurd valuations are justified – whether for tulips, railroad stocks, Pets.com equity, subprime loans, or maybe electric-car makers and purveyors of videoconferencing software.
One conclusion might be that even if the extraordinary central bank response to the pandemic’s economic fallout was necessary, it may also be making a long-term problem worse. That is, unless investors believe markets have now reached Fisher’s plateau.
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