Toby Birch

Articles:

Three Card Brag

By Toby Birch June 2007 Global Markets Online

This card game, originating in the eighteenth century, is one of the purest forms of gambling. Unlike poker, winning is determined more by luck than by skill. Large amounts of money can be won and lost over a short space of time, which is increasingly the case in financial markets. For this article we will consider the three-way bet that is going on right now for investors, which fall into the following categories:
1. Wild bull
2. Range-bound rollercoaster
3. Crash and burn

1. Wild bull
This is of course the most favoured option for people in finance. There is everything to be said for a bullish or positive approach to markets where advertising material and product offering is concerned. Clients want to hear an upbeat message and for the last 25 years the buy and hold mantra has generally held good. The investment business also benefits by taking a slice of the upside from rising markets while suffering little on the downside compared losses that clients may face. It is a case of heads I win, tails you lose.

There are compelling arguments for a continued rally in stock markets and asset prices generally. Main market indices appear at last to be breaking through their previous highs witnessed in 2000 at the peak of the TMT bubble. Earnings and profit growth appear to flow from a never-ending spring. Take-over activity is rife as private equity funds hunt down their quarry, moving from small and medium size prey to large cap stocks, gearing up many times in the process. Then there are the central banks that have always bailed out speculators in past crises, by slashing interest rates whenever a crisis emerges. It appears that the US Treasury and western banks alike can mass produce money at will while Asians mop up the excess liquidity through bond purchases.

New and exciting products abound and all appears to be well with the world. Most important, in spite of falling property prices in America, stabilising interest rates and bond yields allow for share prices to rise (much like the 1990s where we witnessed so-called P/E ratio expansion). We could be entering a new era where Europeans and Asians go for growth and take over the baton from flagging American consumers whose property boom has kept worldwide demand afloat. This is known as the de-coupling effect.

2. Range-bound rollercoaster
The charts of markets over the last 8 years are doing a good impression of a rollercoaster with a short, sharp drop followed by a long uphill run. This is very similar to what happened to markets in the period 1966-82 when America's Dow Jones oscillated back and forth between 600 and 1000 on the index without breaking out of the range. In what was a highly inflationary period, investors portfolios were effectively stagnant while their purchasing power was decimated. Sixteen years is a long time to wait before making any money and we may well be at the half way point of a similar long-term ebb and flow in markets. This would imply that a further dip is on the way followed by another 8 years of gyrations.

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