In 2000 one of the world’s foremost economists, Andrew Smithers, showed that the US stock market was widely over-priced at its peak and correctly advised investors to sell. He also argued that central bankers should adjust their policies not only in light of expected inflation but also if stock prices reach excessive levels. At the time, few economists agreed with him, today it is hard to find those who would disagree.
In the past central bankers have denied that markets can be valued and that it did not matter if they fell. These two intellectual mistakes are the fundamentals cause of the current financial market crisis. In addition, a lack of understanding by investors as to how to value the market has also resulted in widespread losses.
It is clearly of great importance to everyone that neither these losses nor the current financial chaos should be repeated and thus that the principle of asset valuation should be widely understood.
In this timely and thought-provoking sequel to the hugely successful Valuing Wall Street Andrew Smithers puts forward a coherent and testable economic theory in order to influence investors, pension consultants and central bankers policy decisions so that thy may prevent history repeating itself. Backed by theory and substantial evidence Andrew shows that assets can be valued, as financial markets are neither perfectly efficient nor absurd casinos.
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About the Author
Andrew Smithers is the founder of Smithers & Co., which provides economics-based asset allocation advice to over 100 fund management companies worldwide. Andrew is a regular contributor in Japan to the Nikkei Veritas. He was a regular contributor to the London Evening Standard and Japan's Sentaku magazine, and has written for many other newspapers and magazines, including the Financial Times, Forbes (US), Sunday Telegraph (UK), Independent on Sunday (UK) and Genron (Japan). Andrew is an invited contributor to the prestigious Economist's Forum on the FT website. Andrew is a member of the Advisory Board for the Centre for International Macroeconomics and Finance (CIMF) at Cambridge and has also been a member of the Investment Committee at Clare College, Cambridge since 1998. Prior to starting his own firm, Andrew was at S.G.Warburg & Co. Ltd. from 1962 to 1989 where he ran the investment management business for some years and which, by the end of his tenure, was the acknowledged market leader. This was subsequently floated off as a separate company, Mercury Asset Management, which was acquired by Merrill Lynch in 1998.
Table of Contents
Chapter 1 Introduction 1
Chapter 2 Synopsis 15
Chapter 3 Interest Rate Levels and the Stock Market 25
Chapter 4 Interest Rate Changes and Share Price Changes 37
Chapter 5 Household Savings and the Stock Market 41
Chapter 6 A Moderately rather than a Perfectly Efficient Market 49
Chapter 7 The Efficient Market Hypothesis 57
Chapter 8 Testing the Imperfectly Efficient Market Hypothesis 67
Chapter 9 Other Claims for Valuing Equities 81
Chapter 10 Forecasting Returns without Using Value 91
Chapter 11 Valuing Stock Markets by Hindsight Combined with Subsequent Returns 97
Chapter 12 House Prices 105
Chapter 13 The Price of Liquidity – The Return for Holding Illiquid Assets 109
Chapter 14 The Return on Equities and the Return on Equity Portfolios 115
Chapter 15 The General Undesirability of Leveraging Equity Portfolios 121
Chapter 16 A Rare Exception to the Rule against Leverage 131
Chapter 17 Profits are Overstated 137
Chapter 18 Intangibles 145
Chapter 19 Accounting Issues 159
Chapter 20 The Impact on q 171
Chapter 21 Problems with Valuing the Markets of Developing Economies 175
Chapter 22 Central Banks’ Response to Asset Prices 181
Chapter 23 The Response to Asset Prices from Investors, Fund Managers and Pension Consultants 191
Chapter 24 International Imbalances 195
Chapter 25 Summing Up 197
Appendix 1 Sources and Obligations 199
Appendix 2 Glossary of Terms 203
Appendix 3 Interest Rates, Profits and Share Prices by James Mitchell 209
Appendix 4 Examples of the Current (Trailing) and Next Year’s (Prospective) PEs GivingMisleading Guides to Value 217
Appendix 5 Real Returns from Equity Markets Comparing 1899–1954 with 1954–2008 219
Appendix 6 Errors in Inflation Expectations and the Impact on Bond Returns by StephenWright and Andrew Smithers 221
Appendix 7 An Algebraic Demonstration that Negative Serial Correlation can make the Leverageof an Equity Portfolio Unattractive 233
Appendix 8 Correlations between International Stock Markets 235