Apple’s rise to a valuation of $2tn, only five months after it was worth half that sum, is astonishing but one can, at a push, suggest half an explanation. Against original expectations, the pandemic has been good for flogging expensive iPhones, dinky headphones and smartwatches. Homeworking has helped.
Yet Apple is only one company and the bigger conundrum is baffling. What explains the rip-roaring recovery in wider stock markets since March in the face of bleak economic news? How has the broadly based S&P 500 index in the US managed to hit a record high, as it did on Tuesday?
Even when one adds Amazon, Facebook, Google and Microsoft to the list of index-boosters, the recovery is mystifying. The S&P has climbed more than 50% since its pandemic low, a performance that puts the bounce-back after the dramatic, but ultimately inconsequential, crash of 1987 in the shade.
Is it confidence that a V-shaped recovery is in progress if only we’d look beyond day-to-day headlines? Is it the wondrous work of the US Federal Reserve in forcing down bond yields via quantitative easing (QE) so that shares can appear to be relative bargains in a zero-rate financial world?
Here’s an alternative view, courtesy of James Montier of influential Boston-based fund manager GMO in an entertaining blast this week: “The US stock market appears to be absurd.”
Montier’s arguments are worth noting, not least because he was in the bullish camp at the depth of the sell-off a few months ago. First, the “it’s QE, stupid” thesis looks fishy.
In each of three major rounds of QE in the US from 2009-15, yields on 10-year US Treasury paper ended the period higher than when the Fed went into action. So investors are placing a lot of trust in the power of the Fed’s financial medicine on the basis of little supporting evidence. “Fed-based explanations are at best ex-post justifications for the performance of the stock market,” reckons Montier.
Second, he is surely right that a V-shaped recovery, while impossible to dismiss entirely, is one of the least likely outcomes. The paths of unemployment, business investment, lockdowns, second waves of infection and consumer spending are all gloriously unclear. A sensible long-term investor, argues Montier, would want “a margin of safety” before plunging into a market that is one of the most expensive of all time when judged by traditional price-to-earnings yardsticks.
As he puts it, the US market in particular (because valuations elsewhere are less extreme) has “priced in a truly Panglossian future where everything is for the best in the best of all possible worlds”. The outside chance of good news is being priced as a certainty.
One can make a case for excepting a few stocks if one wishes (and perhaps Apple is an example) but old-fashioned notions of risk seem to have been widely abandoned amid the overdose of optimism. Absurd is the right description.
Rail needs permanent reform
The rate of increase in rail fares in January – 1.6% if the usual mechanical formula based on July’s inflation figure is applied, or zero if ministers are pragmatic – is not the most pressing issue on the railways.
The top priority is how to replace rail franchising, which was suspended for six months in March when emergency measures agreements, or EMAs, transferred all cost and revenue risks to the government to keep trains running. Operators currently get a flat management fee to run under-populated services.
It should be obvious that a return to old-style franchising is impossible; a discredited system is now also unviable. The operators aren’t going to accept revenue risks when long-term demand for rail travel is wildly unpredictable; even when the pandemic passes, demand on commuter routes will be permanently altered by employers’ embrace of flexible and homeworking arrangements. And the government has no real power to force operators to accept rigid terms; the companies could just hand back the keys.
It is why some form of central control – semi-nationalisation, or a contracting model – looks inevitable. Nor should it be controversial. In the debate about how best to reform the structure of the railways, the consensus had shifted anyway towards a management-fee set-up even before Covid arrived.
Next month the government is likely merely to extend the EMAs while adding a few tweaks, such as ordering operators to adjust service frequencies on certain routes. That’s a reasonable fudge for the time being but a system of emergency arrangements, renewed every six months, will soon frustrate everybody. Permanent structural reform was overdue before March, and is definitely needed now. Let’s see it.
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