Stan: “That’s the first mistake we’ve made since that guy sold us the Brooklyn Bridge”.
Ollie: “Buying that bridge was no mistake. That’s going to be worth a lot of money to us someday.” - Way Out West (1937).
Laurel and Hardy, masters of the physical double-take, in this exchange deliver a verbal one. We laugh once at the hapless pair being duped into buying a national landmark; and again when we realise Ollie still thinks it was a timing error.
But don’t laugh too hard. Plenty of us might be in the same position: will the stuff we have bought eventually come good, or is the basis on which we bought it a mirage?
Investors who persisted in buying ‘value’ through 2010 and 2011 have been thoroughly trounced by those focused on ‘quality’ - effectively, cash on balance sheets today rather than cash from revenues tomorrow.
The value investors point to corporate profits. After the shock of 2007-08, the last three years have seen a rapid ascent back to the trendline established through the IT and emerging market revolutions of the 1990s and early 2000s. Stock prices look as through they are still playing catch-up and the recent sell-off seems to have more to do with the euro-zone crisis than anything fundamental. Staunch that wound - by persuading the ECB to pursue QE - and we’d be back on track.
Sarasin CIO Burkhard Varnholt put the case to me clearly on 29 November: “Investors will shift their attention away from the euro-zone and onto the realisation that the valuation gap between government bond yields and equities is wider than it’s ever been in post-war history, and we will get a very, very strong relief rally.”
But even if we do scrape through with the euro intact, history assures us that corporate profits revert to the mean. Taking our data for US corporate profits back only as far as 1998 would still suggest a number closer to $1.2trn rather than the current $2trn - and perhaps another 20% off equity markets.
There are good arguments against this. GaveKal research points to the growing share of profits that accrue to intangible capital at the expense of labour: if Western economies trade in highly-scalable things (like the intellectual property of microchip design) and export the assembly work, labour prices remain subdued and profits can continue to grow.
But growing the share of intangible capital in the economy requires investment - which brings us back to Stan and Ollie.
Fans will recall that Way Out West revolves around the delivery of deeds to a gold mine to their rightful owner. In the midst of all this corporate profitability, gold mines have been a big disappointment.
It’s not as if people haven’t wanted gold. But convinced as much by the bear market of the 1980s and 1990s, miners failed to invest and kept on hedging, missing out on profits from one of the biggest bull markets in history. Since 2000 gold is up 500% but gold mining shares managed only half as much.
Similarly, when ‘quality’ investors make their choice for ‘cash today’, many do so precisely because they see so many corporates hoarding it: that kind of corporate sentiment could curtail rising profits, the last support underneath equities.