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Paul Gambles
Co-founder of MBMG Group


Update September 24, 2016

Is a horse race a sound market indicator? Part 2

In this part, I look at HSBC’s analysis of whether equities are overvalued if stagnant and explain my view.

The key point is highlighted by HSBC in its white paper, when it explains that bond yields are low versus data since the 1800s for the UK and the US, and data since the 1700s for Holland. In fact, yields have only been so low on two previous occasions, both times in the aftermath of financial crises: the Latin American debt crisis of the 1890s and the Great Depression of the 1930s.1

Yet its bearish equity-market analysis implicitly assumes normalisation of real interest rates, nominal interest rates, and of the term structure. Whilst it’s reasonable to expect some degree of normalisation for today’s historically low rates, HSBC – as well as the bond market – believe that a full mean-reversion is very unlikely.

The White Paper then diverts into an academic analysis of bond yield drives that I’d regarded as a red herring – unless they believe bond yields will never normalise again. They describe it as a “convergence of factors points to the rate environment remaining lower-for-longer, a view which markets have largely come to accept.

Concurrently, the HSBC paper goes on to say, when interest rates do start to rise, “the cycle seems likely to be  slow and low.” Such an outlook, for structurally low interest rates, impact perspective returns for asset classes across the risk spectrum. For equities in particular, it implies that what it was under higher interest-rate regimes, during the 1970s-1980s.2

This tends to ignore economic history dating back to the earliest records of Sumerian civilisation – it’s asking for a huge leap of faith to insist on a seismic shift that totally disconnects today’s world from 5 millennia of human history. HSBC also dismisses the fact that today’s equity markets contain higher equity premiums, which can easily be proven measuring by e.g. Jensen’s Alpha3 and their failure to recognise the reasons behind this.

There is quite a significant body of commentary that explains how the need to generate income or growth in a ZIRP / NIRP environment has led to enforced equity re-rating. Investors who have been forced to abandon their normal risk preferences and behavioural investment studies are extremely well aware of this.

Whilst the HSBC white paper seems to start from a partial point of view, seemingly committed to defending equity valuation levels, it takes a quantum leap in its attempt to measure the prevailing market discover rate. This involves some significant assumptions: “For the US, we assume a rate path broadly in line with the Fed’s forecasts,4 while in Europe we assume that the ECB will persist with its current accommodative policy stance into the near term. Interest rate rises are consequently delayed, as we expect headwinds from the financial and Euro crises to continue weighing on the rate outlook into the medium term.”

They admit that this “encapsulates the notion of a “slow and low” interest rate cycle with divergence between major central banks.” And that “assuming a more hawkish rate trajectory creates a larger capital loss for risky assets as they are forced to de-rate.” That’s as maybe, but it also assumes Goldilocks is alive and well and that not too hot, not too cold, but just right will manage to prevail as Macro-economic conditions for the next decade.

This would truly be a “great moderation”. They also assume at 4% reverting to cyclical norms and a current dividend pay-out ratio of around 45%. They even assure a rate of 2% for European real dividends over the near term. Again, Goldilocks would be happy.

The linkage between such benign interest-rate assumptions of consistent dividend growth for a decade strikes me as wishful thinking, tempered by the authors’ rejection of even more fanciful growth claims. In short this attempted analysis ignores causative relation and the possibility for any shock – it’s a very elegant constructed arithmetical model, yet doesn’t reflect any plausible reason.

This explains why they reach the conclusion, “On this basis, in contrast to the conclusion implied in US bonds, it seems difficult to argue that equities are very overvalued today. Even in our conservative scenario, US equities look fairly valued, whilst European equities look cheap – as do global equities relative to government bonds.”

In fairness, they do set out to answer the question Are equities overvalued if growth is stagnant? But in doing so, they pretty much recognise that their view owes nothing to fundamental value and everything to the freakish conditions created by policy. This undermines their own argument that prices aren’t primarily just a reflection of

Frankenstein’s monetary policy equivalent - their view of the next decade that is ultimately contextual, admitting that as the economic environment evolves, their assessment of available market returns must also change.

So this 10-year view is based entirely on factors today that are hugely changeable; except that “Today, one of market participants’ crucial concerns is of a long-term stagnation in economic growth going forward, which is also likely to create problems for the corporate sector. A lacklustre macro picture would make it difficult for corporates to generate decent free cash flow and dividend growth to reward shareholders.”5

The HSBC’s justifications revolve around a flawed Macroeconomic understanding that ignores the role of excessive private debt in cyclical stagnation. Sadly, they fail to address this in their paper, which is its contrast flaw – if you don’t identify the single greatest prevailing macroeconomic driver and capital market issue, you won’t infer the right answer.

In fairness, having gone out on a limb to justify the unjustifiable, they half admit this is their conclusion “Not overvalued, but we are walking a tightrope.” They state that “A lack of generous market pricing across conventional asset classes implies that we are currently in a low-return world. However, our research does not indicate that equities are overvalued, even under stagnant growth assumptions. Relative to the low returns available on cash or government bonds, we believe equity markets continue to offer fair-to-attractive compensation for risk.”6

However, they sound unconvincing, admitting that the views are all based on a very short term focus. “We do not believe equity valuation can legitimately be assessed according to a fixed benchmark. It must be contextual […] the assessment of equity fair-value relies heavily on how interest rates and corporate fundamentals will evolve. Our approach to valuation is based on the present value relationship linking current prices and economic fundamentals to extract an implied premium (excess return) for equity market.”

Even though they are absent of an understanding of high debt cyclical stagnation, they admit that their roseate view may well be ignoring the dangers that the future holds. “We continue to believe that we are walking a tightrope between forces of “secular stagnation” on the other hand and a combination of better growth and higher US interest rates on the other, with market volatility likely to remain episodic. This combination of heightened macroeconomic uncertainty and low asset-class returns poses a challenge for investors. In this context, we believe that a focus on active asset allocation has never been more relevant.”

Amen to that – but I wonder why such a reasonable conclusion was preceded by such an arithmetically eloquent justification of the unjustifiable. HSBC seem to think equities aren’t overvalued because looking out from very unsound foundations today we can’t see the cause of a major correction happening tomorrow. But then markets rarely can, so I don’t believe that is the same as saying equities aren’t expensive. At some stage equities will correct.

Until then, whether that is tomorrow or in 10 years’ time, equity returns are likely to disappoint. As a risk – adjusted value advisor, that implies to me that equities are, in general, too expensive to invest in. Most other asset classes are and valuations are both contextual and relative.

But for now I’d rather keep out of all the dung in the farmyard, rather than trying to pick a favourite and that’s why I’ll be very circumspect with my equity appetite for equities this St Leger Day.



2 idem


4 Fed Summary of Economic Projections, March 2016


6 idem

Update September 17, 2016

Is a horse race a sound market indicator? Part 1

In the world of finance, you hear a lot of sayings and superstitions. I even heard someone say “buy Apple shares” once. But there’s one old adage that might actually have some substance.

The saying I’m talking about is Sell in May and go away, buy again on St Leger Day. The day in question is the St Leger Stakes, the final horse race of the English Triple Crown. It takes place in September and is the traditional end of the season. The saying refers not necessarily to the specific date of the race, but generally staying out of the market during the less-profitable summer months and investing fully in the winter.

Of course, it’s not always true – it’s quite possible that returns can be made in the summer months. If we average the S&P’s monthly performance since 1950, we can see there is a definite trend in favour of walking away from the market in May (see chart 1).

Chart 1 - Source: & S&P.

There’re also some plausible causative factors. For example, in the UK there is often a lull because of the new tax year; whereby activity increases towards the end of the previous fiscal year, pulling forward buying whilst delaying selling. Of course it also has a lot to do with thin volumes because of the summer holidays.

But this year we should also focus on equity valuations too as they’re the key defining point behind where we’re at. A recent white paper by HSBC asked, “Are equities overvalued?”1 It begins by referencing the father of value investing, Ben Graham, who famously likened the stock market to a voting machine in the short run and to a weighing machine in the longer run. In other words, over a short period of time equity prices may move away from fundamentals, but over a longer period there’s not such a large gap. Current valuations are in no small measure a reflection of unprecedented policy, the “sugar high” that, when it wears off, will give rise to market weakness and volatility.

In the white paper, HSBC disparage as bearish the view, “The idea that there should be mean-reversion back to long-run averages is typically made with reference to equity valuation metrics.” To illustrate this the paper took a selection of popular price ratios against their historic average readings: below are the 3 that have the greatest very long term substance (see table).

Table - Source HSBC.

HSBC admit, “Many of these metrics remain well above historic averages. Using a long, 100-year time series to benchmark these readings adds further plausibility to this argument.”2 I’d prefer to note that the 3 key metrics show an overvaluation of 89% which becomes 90% if Warren Buffet’s favourite valuation metric, Market Capitalisation to GDP, is added to the mix. I’d excuse normal P/E ratio as less relevant because the data quoted by HSBC only date back 1971; a very misleading data subset.

HSBC explain that the “Shiller PE, for example, is a widely-followed metric, which compares the current equity price to smoothed (10-year) earnings. Academic studies have evidenced a strong link between high Shiller PEs and weak future long-run equity returns.3 Today, it’s reading over 24, a situation which Professor Shiller argues has occurred only infrequently (in 1929, 2000, and 2007) and has each time been followed by a market collapse.

As Shiller wrote in the  New York Times last year:4

It is entirely plausible that the shaking of investor complacency will …. take the market down significantly and within a year or two restore CAPE ratios to historical averages. This would put the S&P closer to 1,300… and the Dow at 11,000. They could also fall further; the historical average is not a floor.

After the recent market rout and rapid rebound, the S&P is trading at around 2,050 and the Dow at around 17,500. If Professor Shiller is right, there is significant further downside to come and investors need to be extremely wary of the outlook for equities.

The market capitalization-to-GDP ratio is also significantly ahead of historic norms. HSBC also explain Tobin’s Q – a measure widely followed by macroeconomists, which charts firms’ asset value against current market value. Current levels are also showing an extreme reading relative to their 100-year average.5

Their summary of the data is, “The point is, as Professor Shiller eloquently puts it, that equity price ratio analysis leads many economists to conclude there are predictable further losses ahead. The assumption is that what goes up (“unsustainably”) must, eventually, come down.”6

In similar vein Coram’s James Sullivan recently noted that the last time that UK leading economic activity indicators were at current levels the FTSE was below 4,000!

However, HSBC does not believe the issue is quite so straightforward. They argue that ZIRP or NIRP changes the inputs that have to be used for equity valuations which the white paper lays out – HSBC then construct their own case by the classic Gordon growth model.7

Relying on an equity valuation model that could well be inappropriate, they also make an assumption that “government bond yields have not behaved like classic sine waves historically. Rather than mean-revert neatly, bond yields have historically alternated between phases of stability coupled with temporary mean-reversion and significant “jumps”. These jumps coincide with shifts in the economic regime.”8

That’s all very well, but it ignores the clear long cyclicality of interest rates underlying shifts in equity valuation parameters. Adjusted for these factors bond yields are, in my view actually quite consistent, other than the scales of rate blow-outs in the 1970s and 1980s, which are explained by executing markets at the time (see charts).9

Historical US Government Bond Yield

Chart 2 - Source: HSBC.

Historical UK Consol Bond Yield

Chart 3 - Source: HSBC.

One key question that will impact equity prices is whether bond yields have pulled forward the low point or could it still be as much as 10-15 years ahead of us. I believe that this is the key question to answer, although I concur with HSBC that bond yields are “very low relative to the last 30 years, meaning the phase of bumper asset returns we enjoyed since the 1980s is over and, mathematically, cannot occur again from current levels.”10

Therefore, the importance of bond yields is that, despite HSBC’s views, ZIRP and NIRP are key factors in equity valuations and this support will ultimately be removed. Accepting this, trying to justify valuations at today’s levels seems like a futile process if we agree that:

1. Equity valuations are vulnerable to normalization of interest rates that could start to occur at any time in the next decade or two.

2. Until then equity returns are likely to be disappointing anyway.

Consequently, I think that the key valuation issues are that equities are expensive today because at some point, which may or may not be imminent, a major equity correction is inevitable and until then equity returns will be disappointing – like pennies in front of a giant bulldozer? To me, that implies equities today are overvalued.

HSBC on the other hand seem more interested in the intellectual exercise of justifying today’s valuations is today’s context and therefore disproving that a significant correction is imminent. This is interesting but, for me, less useful.

In Part 2, I explain why.



2 idem

3 e.g. Campbell and Shiller (1997), Valuation Ratios and the Long-Run Stock Market Outlook, Journal of Portfolio Management,



6 idem

7 Gordon (1959), Dividends, Earnings and Stock Prices, Review of Economic Studies

8 Bansal et al (2003), Regime-Shifts, Risk Premiums in the Term Structure, and the Business Cycle, Duke University Working Papers

the -housing-market-trying-to-cause-inflation-researching-the-1970s-and-1980s/


Update September 10, 2016

The beginning of the end of Austerity? Let’s hope so

After all the promises of several governments to “save, invest and export”1 and the enactment of laws to reduce deficits, it seems that all this hard talk of austerity is turning out to be a load of hogwash.

In June of this year, economists at the IMF – the world enforcer of austerity – published an article questioning its own approach, stating:

Austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand—and thus worsen employment and unemployment.2 

A month later, the UK’s incoming Chancellor of the Exchequer, Philip Hammond, indicated a scaling back of predecessor George Osborne’s book-balancing programme.3 Then, consistent with two years of the Italian government speaking out against austerity, its economic development minister, Carlo Calenda, spoke in August of how it was “fighting to change” the 2017 reduction target of 1.8%, set by the European Commission.4

It seems that, in Europe at least, cracks are beginning to form in the grand plan to reduce government debts. And about time too!

Frankly, austerity, fiscal responsibility, balancing the books, however you want to label it, has been one of the great disasters of post-GFC policy. And that’s saying something, when you consider that it shares its infamy with quantitative easing and negative interest rates.

The whole idea behind austerity comes from the governments’ apparently sudden realisation that they were cranking up massive public deficits through borrowing. This particularly came to the fore when, in some cases, public money was used to stop the banking system from collapsing under the weight of its own bad loans.5

So it makes sense that governments offset these massive costs by tightening their belts to the point that they bring in more money than they spend, right? Wrong.

A government’s balance sheet is in no way the same as that of a company or an individual’s credit card bill. The belief that it is similar betrays a total misunderstanding of what money is and where it comes from. Governments create money by borrowing from banks, so bank notes are in fact a collection of IOUs. If you’ve ever looked at an English bank note, for example, you may have noticed the Governor of the Bank of England’s signature and a promise to pay the bearer the sum of the note.

So, if there were no national debt, governments wouldn’t have to borrow from banks. The banks would then have to create all the money themselves through private loans. The problem is that there simply aren’t enough private borrowers for the banks to do business in that way.

Even if we disregard that reality, if you try to cut national debt you’re actually reducing demand in the economy, which then reduces national output because firms cannot sell enough. Three countries whose governments have recently run a surplus – Chile, Denmark and Sweden – have seen a reduction in GDP and an increase in unemployment during periods of belt-tightening (see chart 1).

Chart 1 - source IMF.

This reduction in GDP highlights the nonsense that has been circulating the corridors of the European Commission, the ECB and the IMF over the past seven years. Their focus is on reducing public debt, seemingly irrespective of the cost to a country’s social and physical infrastructure; yet they use the percentage of public debt to GDP as the main measure.6 That’s the economic equivalent of jumping at shadows; because both debt levels and GDP figures are moving variables. So if, as in the cases of Chile, Denmark and Sweden, the government is able to bring in more money than it spends and GDP shrinks, the debt-to-GDP ratio will not improve – and may even worsen.

In fact, economist Ha-Joon Chang recently pointed out that in the now infamous case of Greece, the result of 5 years of austerity is merely more public debt as a proportion of national output than before (see chart 2).7 So what we’re looking at is a situation whereby, not only is the policy of austerity flawed, but so is the way of measuring success – or, more the point, the lack thereof.

If we take our minds away from the mind-set of central banks and the IMF for a while and instead apply some basic logic, it seems a fairly straightforward statement to suggest that governments receive their income from taxes, such as corporate and personal income taxes, sales and property taxes.

It’s also not particularly controversial to say that - as has happened in Greece - if a government raises corporate and personal income taxes and cuts the minimum wage (by 22%),8 pensions and public sector salaries,9 as well as increasing sales tax up to 24%,10 businesses and families have less money to spend. Not only that, unemployment tends to increase as companies either can no longer afford to or feel nervous about committing themselves to employ – as has happened in the worst-hit Eurozone countries (see chart 2).

Chart 2 - source Eurostat.

Consequently, investment and consumption drop and the economy shrinks. That in turn brings in less corporate and personal income and sales tax revenue to the government. Hey presto, that’s where Europe is now.

The solution to this is not so complex either. In a nutshell, governments need to put money back into the hands of the people. There are several ways to do this. My IDEA Economics <> colleague Michael Hudson talks of society’s rich history of debt jubilees,11 used to wipe the slate clean and recharge the economy. As he says, “Debts that can’t be repaid, won’t be repaid,” so a cancellation removes the shackles.

There’s also the possibility of actually increasing government expenditure on important services such as health, education, digital and physical infrastructure. This would provide a long-term economic climate where the private sector is able to invest and spend and thus bring in more tax revenue for the government to reinvest. Of course that depends on the public sector using the money on its people, rather than wars.

In the meantime, we can apply pressure through reasoned argument until the penny/cent/yen eventually drops and the vicious circle is turned into a virtuous one. My fear, though, is that this will be ignored and it will take another huge economic crisis to trigger such a rethink.


1 Then UK Chancellor of the Exchequer George Osborne’s 2010 Budget Speech,

2 Jonathan D. Ostry, Prakash Loungani & Davide Furceri, Neoliberalism: Oversold? Finance & Development, IMF, June 2016




6 &






Update September 3, 2016

Thailand: Solid GDP results – but can they continue?

In Mid-August Thailand’s National Economic and Social Development Board published GDP figures for the 2nd quarter of 20161 – and they were impressive.

The Land of Smiles’ production was up 3.5% on Q2 of last year, following on from a year-on-year increase of 3.2% in Q1. This is particularly indicative of the strength of Thailand’s economy for two reasons: its performance in comparison with major economies; and because the country has an export-oriented economy.

For almost two years, production has been increasing at a faster rate than Australia and has recently begun to outperform the US (see chart 1).

Chart 1 - Sources: NESDB, St Louis Federal Reserve, ABS.

Exports account for over 69% of the GDP (2014 figures2). The country mainly exports manufactured goods (86% of total shipments) – particularly electronics (14%) and vehicles (13%). Agricultural goods, mainly rice and rubber, represent 8% of the export market.3 The kingdom’s major export partners are China (12%), Japan (10%), the United States (10%) and the European Union (9.5%), machinery and equipment (7.5%) and foodstuffs (7.5%) being the most important.4

In this poor global trade environment, Thai exports have suffered, like those of most other nations. Exports from Thailand decreased slightly by 0.1% year-on-year to USD18,150 million in June of 2016 (but not as bad as market expectations of a 2.02% decline) following a 4.40% drop in May, marking the third straight month of year-on-year falls. Outbound shipments shrank to China (-11.9%), followed by Japan (-3.8%). However, in contrast, exports were up to the US (+4.7%) and Europe (+0.9%).

From January to June 2016, exports increased by 5.8% in terms of price and 5.2% in value compared with the first half of 2015 (see chart 2). Although this was somewhat to do with currency values: for example, the Baht, in the first half of this year, was 6.4% stronger in H1 2016 than in H1 2015.5 In fact the volume of exports in H1 2016 was in fact slightly down (0.1%) on H1 2015 (see chart 2).

Thai Exports

Chart 2 - Source: Bank of Thailand.

Exports in Thailand averaged USD9,648.32 Million from 1991 until 2016, reaching an all-time high of USD21,227.12 million in August of 2011 and a record low of USD1,997 million in February of 1991.6 Although, when looking at this 25-year period we have to take into account that Baht values have fluctuated some 116% over this time.7

So against a very difficult multi-year backdrop, that worsened significantly during H2 last year when China’s slowdown started to have a greater impact,8 exports seem to have stabilised; yet they remain vulnerable and this puts pressure on the other drivers.

Also the results are very impressive in view of Thai disinflation - there’s very little inflation component to the GDP growth. It’s much more akin to ‘real’ growth.

Chart 3 - Source: Bank of Thailand.

What’s more, the consumption component of GDP is also challenged – high consumer debt, especially in the lowest income quintile9 and also the lowest incomes facing headwinds because of this year’s drought conditions10 (remember around 42% of the Thai workforce is still in agriculture11) declined, so consumption contribution to GDP remains difficult and lower consumption12 and weak exports also constrain the private investment component of GDP.

The two bright spots had been tourism and the public sector investment and expenditures. Although the stability expected following the referendum should be seen as a positive towards enabling the NESDB’s revised annual target of 3%-3.5% growth13 - which given that Thailand is currently experiencing deflation, is a real challenge. It should also allow the government to continue to focus on implementation of its infrastructure plan without too many distractions. However, the news of attacks in tourist areas that have left several people dead and scores injured since mid-August could be a real challenge to the tourism component unless this can be shaken off quite quickly. If not, that would be further pressure on public sector investment to raise GDP. Whilst the NESDB claims that the explosions are unlikely to affect economic growth,14 it’s far too early to know or even predict.

On the bright side, the acceptance of the new constitution through the referendum, clears the path to implement a lot of the investment. The fear was that with a negative referendum result, there would have been distractions to the implementation of the investment plan.

That said, I agree with Kasikorn Bank director and head of market & economic research Kobsidthi Silpachai’s analysis when he said that, now we have made the step towards a new constitution, in the coming sixteen months leading up to an eventual general election in Thailand, the economy will probably continue to have the same kind of economic activity dependency on both government spending and tourism.15

That dependency on two main variables means, despite the relatively good results, we cannot too carried away.



2 World Bank

3, August 2016

4 idem





9 Research/SymposiumDocument/Paper4_2557.pdf


11 World Bank

12 Thailand: consumption the weak link DBS Group Research 25 January, 2016




Please Note: While every effort has been made to ensure that the information contained herein is correct, MBMG Group cannot be held responsible for any errors that may occur. The views of the contributors may not necessarily reflect the house view of MBMG Group. Views and opinions expressed herein may change with market conditions and should not be used in isolation.
MBMG Group is an advisory firm that assists expatriates and locals within the South East Asia Region with services ranging from Investment Advisory, Personal Advisory, Tax Advisory, Corporate Advisory, Insurance Services, Accounting & Auditing Services, Legal Services, Estate Planning and Property Solutions. For more information: Tel: +66 2665 2536; e-mail: [email protected]; Linkedin: MBMG Group; Twitter: @MBMGIntl; Facebook: /MBMGGroup


HEADLINES [click on headline to view story]

Is a horse race a sound market indicator? Part 2

Is a horse race a sound market indicator? Part 1

The beginning of the end of Austerity? Let’s hope so

Thailand: Solid GDP results – but can they continue?