Rout in bank shares proves that stock market is unreliable measure in real world
Smaller investors have no need to keep tampering with their portfolios as long as they started out with investments based on solid fundamentals
Anyone wanting a textbook example of the unreliability of stock markets as measures of either corporate or economic prospects need only refer to last week’s extraordinary rout in bank stocks.
Even without a rear view crystal ball, the favoured instrument of many market commentators, it was easy to see that despite all the understandable worries about the state of the global economy, the one sector that always emerges smiling from these crises is the banking sector.
This puts into perspective some of the wilder talk heard last week during the massive bank stock sell off. The reality is that when it comes to the bigger banks, even when they are in trouble, they are firmly in the category of “too big to fail” and before anyone cites the example of the Lehman collapse in the United States to disprove this point they should remember just how exceptional this was; why, even in free market Hong Kong, banks were effectively bailed out by the government during the 1980s crisis.
But bigger banks rarely reach this dire situation of collapse, especially nowadays where there is heavy regulation of reserve requirements, controls on lending, etc. Far more typical at times of crisis is the ability of banks to buy up all manner of assets for a song as a way of recovering bad debts.
Yet people in stock markets love to panic. Last week we saw the shares of the mighty Deutsche Bank given a real pummelling. This share price slump contained a large element of self-fulfilling prophecy as the market decided that Deutsche was in real trouble; indeed when John Cryan, its co-chief executive, issued a memo stating that the bank was “rock solid”, this was seized upon as evidence of the reverse.
Even when Germany’s finance minister declared that he “was not worried” about Deutsche, this too was taken as an indication that the bank somehow lacked official support.
As ever, calm reasserted itself not just at Deutsche but elsewhere in the banking sector and we have seen bank shares pushing up again.
Only a boring pedant would have been dull enough to point out that European banks have greatly improved their liquidity ratios in recent times and that the healthy profits recorded last year are more than likely to be reflected in this year’s earnings. US banks meanwhile mostly beat their earnings estimates for the last quarter of 2015 even though some slowing is expected this year.
The herd that charges through these markets likes company and generally fears being separated. The herd has, for example, had a rather longer held opinion that Japan is somewhere around being dead in the water. This is despite the fact that many of the world’s leading manufacturing companies are Japanese and that the Nikkei’s historically high price earnings ratios have shrunk considerably, offering bargain prices for blue chip companies.
These boring old facts however are not likely to bother the denizens of stock markets. That’s why I’ve always loved the famous joke by the economist Paul Samuelson about stock markets having been able to predict nine of the last five recessions. It can equally be said that market pundits have predicted nine of the last five market bull runs.
It is not just that predicting markets is problematic because hard-to-predict stuff happens, nor is it worth complaining about the timidity of fund managers who hug their allocations as close as possible to the various market indices, thus institutionalising herd behaviour. No, it is more than this because markets have a logic of their own and it is often not the logic of the underlying assets they are supposed to represent.
Thus it is quite possible to argue that however sound the banks were last week it was perfectly logical to have taken a punt on their shares falling, simply because the markets were in a mood to mark them down.
This is hardly a novel insight into the way that markets work but in airily accepting the extent to which mass psychology is one of the most useful tools in predicting market movements, the staggering extent to which this is true is often underestimated.
Last week’s bank rout gave us a wonderful opportunity to see this in action, encapsulated in a perfect mini-storm that produced far more thunder than actual rain.
The lesson of all this is to whip out one of those chipped mugs bearing the famous British wartime slogan “keep calm and carry on”. This may be something of a cliché but there is a timelessness to this advice and it is most certainly useful to smaller investors who really have no need to keep tampering with their portfolios as long as they started out with investments based on solid fundamentals that can be summed up in two words: Track record.
Stephen Vines runs companies in the food sector and moonlights as a journalist and broadcaster