Was it wrong to worry?

Friday, 24th August 2018 15:17 - by Eric Chalker

  A year ago, I wrote an article (“An insistent drumbeat…..” 25^th Aug 2017) noting a dozen major threats to share prices and discussed how to react.  Since then, stock markets have actually risen.  The FTSE 100 now stands at 7563, up 2.4 per cent in 12 months.  The FTSE 250 is 20665, up 4.7 per cent, the Small Cap is 5842 (up 2.9 per cent) and the AIM All-Share is 1093 (up 9.0 per cent).  It therefore seems fair, on this public platform, to question whether I was wrong to write what I did.

  In the USA, of course, the rises have been much greater: 16.5 per cent in the S&P 500 and 25.1 per cent in the Nasdaq.  This is the week in which, as the Daily Mail put it, “Wall Street clocks up the longest bull run in history.”  To the surprise of some, including this writer, but to the delight of many, share prices have continued to rise, fuelled by many factors but principally the vast amount of money created by governments accompanied by ultra cheap credit.  These factors are now being reined back, but their consequences, most notably an explosion in debt, share buy backs on a massive scale and ballooning passive investing (because everything seems to be going up), show no signs of restraint. 

  Some observers – just as a year ago – believe this bonanza in equity values will continue.  Other observers – also just as a year ago – believe at least a 20 per cent downturn cannot be long in coming.  For the past year, the first group has been right, but will share values continue to rise and, if they don’t, how big could the downturn be?  Jeremy Warner, in The Daily Telegraph this Wednesday, told us “Not since 1929 have the stock markets looked so precarious”.  But the Daily Telegraph, like the Financial Times, also tells us that the FTSE 100 price/earnings (PE) ratio is less than 13, which suggests that share prices are not unduly high.

  Mark Robinson, in last week’s Investors Chronicle, even wrote that, “Certainly, the FTSE 100, with an average PE ratio of 12.9….. looks….. compelling value.”  But I don’t think he’s right about that, even though his figure agrees with that in the FTSE Actuaries Share Indices.  The latest PE ratios published by the Financial Times are:  FTSE 100 12.57;  FTSE 250 15.78;  FTSE 350 13.01.  But I think they’re misleading.

What are the true current values?

  The Sunday Times publishes a list of the top 200 shares with their PE ratios.  In the latest list, 28 companies have no PEs, presumably because in the previous year there were no profits for the share prices to be measured against.  This leaves 172, with PEs ranging between 2.3 and 239.8.  The average PE here – that is the column total divided by 172 – is 25.4.  This is double the FTSE Actuaries figure for the FTSE 100 and 60 per cent more than for the FTSE 250.  How can this be?

  PE ratios in The Sunday Times list agree with those in the weekend Financial Times.  However, the Financial Times includes some negative PEs where The Sunday Times simply shows a blank.  For example, Barclays is currently shown in the FT with a negative PE of 458.  Clearly, if the FTSE 100 and FTSE 250 PEs calculated by the Institute and Faculty of Actuaries include these negative figures, this would explain at least part of the striking difference between its figure and the average of those in The Sunday Times.  Another possibility is that the FTSE Actuaries figures use a weighted average, but nowhere does it state this and, personally, I would not regard such an average as appropriate in this context.

  For me, an average price/earnings ratio of 25.4 for 172 top companies is certainly not indicative of “compelling value”.  On the contrary, after 3,453 days of the longest bull run ever, an average PE ratio of 25.4 is a red light.  Given where we are, I do not understand how, for example, Questor in The Daily Telegraph can recommend, as it did this week, Hargreaves Lansdown – fine company though it is – as a ‘buy’ on a PE of 44.3.

Reviewing my own decisions

  While writing my article a year ago, with its quite strong suggestion that one should at least sell some shareholdings and hold more cash, I stopped to consider my own position.  This prompted me to sell some of my own holdings in order to increase my cash.  In fact, I doubled my cash to about 15 per cent of my investments.  Since then, apart from switching my ISA holdings to increase the dividend yield (and I’m no longer automatically reinvesting those dividends), I have been extremely wary of new investments.

  So, as the market hasn’t crashed, have I Iost out?  Well, the answer is yes, because all the shares I sold have risen since.  Given the shares I chose to sell, this is not what I expected, but evidently they were better shares than I thought.  Even so, I am comfortable with the decision I made, partly because, despite the forgone profits on some of my wealth, I still made an overall percentage return in 2017 well into double figures.  More importantly, the reason I made the sales was to avoid losing money, irretrievably, when the still expected, major market downturn arrives.

  This is a form of insurance, a precaution, even though I always knew it might mean forgoing something better.  That the market hasn’t yet crashed isn’t the point.  If one’s house doesn’t burn down, or isn’t burgled, one doesn’t normally regret the cost of insurance paid to protect against something which is no more than a possibility.  Taking some money off the table in anticipation of what looks like a certainty seems equally sensible.  It has given me comfortable nights, as it removed concerns that cash requirements might mean selling after a market collapse.  It has also given me the opportunity to buy at substantially lower prices afterwards.  This remains the case. 

Eric Chalker, UK Shareholders’ Association Policy Co-ordinator & Director, 2012-2016

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.