On Friday 5 August, the US S&P 500 and NASAQ composite set new records. Right now, in the UK, the FTSE 100 is looking promising, a new record may beckon for later this year. But how real are these records? There’s a good metaphor from athletics, and we can begin at the Mexico Olympics of 1968.
Bob Beamon was a talented US long jumper. They said he had the potential to be great, but was known to be erratic, as likely to jump a foot in front of the marker board, as tread beyond it, getting a no-jump. In the Mexico Olympics of 1968, it all came right. He timed his leap perfectly, and from the crowd in the stadium there was a gasp of astonishment. He took-off from the board, and appeared to hover in mid-air, before landing, no less than 19¼ inches further than anyone had jumped before. In the pantheon of world records, it was one of the greatest, Beamon skipped a foot, extending the world record from 27 foot 4¾ inches to a distance beyond 29 foot, a feat that had been thought impossible.
At that time, commentators suggested the record might stand for decades and most confidently forecast it would remain well into the 21st century.
In stock market terms there is an equivalent. On March 10, in the year 2000, the NASDAQ Composite closed at 5,048. It had been quite a run. The Index had more than doubled in 18 months, quadrupled in three years, and risen ten-fold in less than ten years.
How could such rises have been justified? We were given two main explanations. The first was that the ultra-low interest rates of the late 1990s justified higher valuations. The other related to technology, and how it was changing the world. We were told that this time it was different, and that higher share prices were justified.
But it was a similar, although less extreme, story for stock markets across the world. The FTSE 100 peaked on December 30 1999, closing at 6,930, from around 4,000 three years earlier, and half the 1999 record five years earlier.
As it happens, the Beamon record lasted for 23 years, finally falling to US athlete, Mike Powell, in 1991. Oddly enough, the Powell long jump record is less famous, but so far has stood for 25 years, even longer than the record it replaced.
Stock markets crashed soon after those peaks of the late 1990s and early 2000s. The FTSE 100 went back down to 3,500 odd in the first few months of 2003, it rose over the next few years, went within almost 200 points of the record in 2007, crashed again in 2008, falling back to the 3,500 ‘ish’ level in 2009, but finally passed the record in April 2015. Right now, the record for the FTSE 100 is 7,103.98. On August 5 2016, it closed at 6,793, it is within whispering distance of the record, to put it into long jump terms, no more than couple of inches away. The odds that the record will go this year are quite good.
For the NASDAQ, this index fell back to 1,300 odd 20 months or so after breaking its record, and didn’t finally climb back to record territory until 2015. The latest record is 5,221.12.
It took 15 years between records for the NASDAQ, so the record stood for a much shorter period of time than Beamon’s famous leap.
Of course, when Bob Beamon re-wrote the record book, he was jumping at high altitude. At those same Olympics of Mexico 1968, world records were broken at the men’s 100, 200, 400 and 400 metre hurdles, with Britain’s David Hemery claiming the last of those records. Cleary, the fact that they were at high altitude distorted performance.
As for stock markets, we are in rarefied air today. For the NASDAQ and S&P 500 small rises can mean new records.
But are recent rises justified?
The UK economy is in danger of falling into recession. The US economy had a bad first half of 2016. In the US, the latest earnings season was a disappointment. Facebook, Amazon and Alphabet did well, but across much of Wall Street results were mediocre at best.
As for the UK, markets have been helped by the falling pound, as the sterling conversion of earnings from foreign subsidiaries of multinationals listed in the UK have risen, even when results measured in local currencies are not so good.
One way of trying to judge whether stocks are fairly valued is to look at valuations to earnings. In the US, the Shiller cyclically adjusted PE ratio (CAPE), which compares valuations to average earnings over the previous ten years, currently stands at around 26. This compares with an historical average of 14, but then this looks at data going back to 1881, so this may not be a reasonable measure. Even so, if we exclude the period of the late 1990s, the CAPE is not far off a record.
As for the NASDAQ, a case could be made for saying that the fact this index is now above the dotcom high shows that the dotcom hype has now be realised.
It is just that there are other records in the world of athletics. The women’s, 100 metres world record was set by Florence Griffith Joyner in 1988, as was the women’s 200-metre world record. The women’s best 400-metre time goes back even further to 1985 – Marita Koch, and the women’s 800 metre to 1983 – held by Jarmila Kratochvilova.
Lean in close, the next bit will be whispered, but not everyone believes that those records of the 1980s were set fairly – there is this suspicion, unproven and this may be wrong, that certain substances may have been used to boost the results. There, said it.
Stock markets cannot be boosted by anabolic steroids, in the past they have been boosted by madness of crowds instead.
But there is a case for arguing that high stock markets can be justified by lower interest rates. The logic runs like this: when analysts value a company, they are meant to estimate future dividends and discount them to give a net current value. So if expectations for future interest rates fall, which they have of late, equity valuations should rise.
But there are two parts to the equation. One part, expectations of future interest rate has changed to favour stocks. But the other part of the equation, future earnings and dividends, is even more important. The fear is that rates are so low because global demand is too low, which in turn may mean future earnings will be adversely affected, which does not auger well for stock market valuations.
So that’s lot of hurdles that have to be cleared. One of these days a new long jump record will be set. How much further stock markets have to rise depends on the future of interest rates, which surely cannot fall much lower, and earnings.
Maybe the best hope for future earnings and athletic records boils down to the same thing – technology enhancing performance.