Financial distancing

Have you ever wondered why in financial markets, red is down and green is up?

It’s ubiquitous, right? I’m thinking traffic lights, on/off lights on electronics, big red stop signs on roads.

in science class at school you probably had to put light through a prism, to split it up into colours. It’s the same effect that gives us rainbows.

Well it turns out that red is the colour that travels fastest through the air to the eye. It’s the most striking.

Blood is red because we want to be alert to its presence as fast as possible – another evolutionary trait.

And it’s why red is used for a certain range of imagery in art, film, and advertising…

And it’s used for STOP on the roads, for blood, and for losses in our portfolios because we need to be aware of those the fastest, as they are a threat to our physical or financial wellbeing.

And its connotations with fear, pain and panic exacerbate the fight or flight panic instincts that we are all feeling now.

There’s blood pouring from our screens, almost every day. Our portfolios are bleeding, and all sings are telling us to stop.

Last Friday I wrote to you, trying to calm the nerves.

Here’s one quote about buying stocks in late ‘08 and early ‘09:

If the world isn’t going to end, this is a great time to be buying stocks.

And if the world is going to end, then who cares about stocks?

I realise though that the losses are eye-watering, and deeply painful and concerning, so I don’t want to bang on that drum too hard, and failing to recognise that people might be looking for other solutions.

Because there are plenty of arguments for ways in which this could get worse.

A recession, unemployment, bank busts, debts unpaid, shale going bust… all these things are yet to play out really, except in investors’ nightmares of course.

One thing that is in very few people’s nightmares is inflation. Everyone thinks that inflation is dead but the incredible stimulus given by governments across the world will give reversing that trend a seriously good go. Inflation is bad for stocks and bonds over a longer period of time.

Or what about this more niche reason to be fearful, from the (brilliant) Bloomberg columnist John Authers:

Ian Harnett of Absolute Strategy Research Ltd. in London pointed out that one of the most successful timing measures for market lows was developed for the Episcopalian Church, and used the advice of clerics on how long people typically take to deal with bereavement. The answer was from 11 to 14 months. The so-called Coppock Indicator amalgamates the percentage move over these periods. When this figure is negative and starts to rise, it is generally a great time to buy the market.

The problem is that the Coppock Indicator is still positive. The chances are that it will be months until this process of financial bereavement, which is linked to an all-too-real sense of human bereavement, moves far enough for a lasting recovery.

Or, those who look at technicals would say there is a strong argument that, in the US especially, the markets’ incredible 11-year bull run was essentially a fabrication. That it was born of financialisation, debt and central bank policy, and that all of that must unwind before we get closer to reality and fairer valuations.

The S&P 500 still has a long way to fall (from 2,304 at Friday’s close) before hitting 2007 highs (1,550), or 2009 lows (666, which is pretty sinister).

Source: Koyfin

In the UK, our FTSEs are all well below their ‘07 highs, and making pretty good progress towards ‘09 lows already, but the US’s everything bubble has a lot of correcting still on the table.

The S&P 500’s cyclically adjusted price-earnings ratio (Shiller PE) is still way above normal, skewed as it is by having zero major corrections in the last ten years.


So is the Warren Buffett favourite, the total market cap to GDP figures in the US (as of 3 March):

So, while I did offer some reasons to be positive, and possibly reasons to start thinking about being a buyer of equities again, I completely understand those that don’t share my view. The stockmarkets in the US really were quite overvalued, and so are now just less overvalued or close to fairly valued, rather than cheap.

In that case, maybe there is still further to fall. And there are some assets in particular which will perform well as stocks fall, or as central banks unleash their full power. They can protect you from the fallout of the financial meltdown, or are durable in the face of inflation.

In fact, a friend of mine, Nick Hubble, has been working on a special bit of research on how to safeguard your wealth in times like this. If you’re lucky he might let me share it with you at some point. He is truly the most expert person I’ve ever met when it comes to working on financial crises and ferreting out excess and danger in the financial system. .

In the meantime, the inflation theme is something I want to expand on next time, and with the Federal Reserve announcing “unlimited QE” this morning it seems like quite good timing. For 30 years we have had falling inflation and interest rates, both a boon for stocks and bonds. That’s about long enough for everyone to forget about it, and assume that the current direction of travel it set for life.

But there’s a lot of reasons to challenge that view, and while 30 years is a long time, it’s not forever and we’d do well to remember that changes of this magnitude have happened before, and it would be timely to reconsider the possibility now.

So that’s all from me until Wednesday, and I look forward to writing to you then.

All the best,

Kit Winder
Investment Research Analyst, Southbank Investment Research

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