Plenty of signs of froth in equities

Last updated: November 25, 2013 9:14 pm

Plenty of signs of froth in equities

By James Mackintosh

Prepare for slower but still acceptable share gains

Equity markets move in cycles, from despair through disbelief to euphoria and back. One of the skills of the investor is to judge where in the cycle they are, and invest accordingly. At the moment, there are plenty of signs of froth. Perhaps the market is reaching the euphoria stage? Peter Oppenheimer, European equity strategist at Goldman Sachs, thinks not. He puts the region in the third phase of a four-stage cycle starting with despair, hope, then growth and finally optimism.Since 1973, the typical cycle has seen hope last for 10 months, driven by increased valuations in the expectation of profits to come. The growth phase then delivered profits over three years, while the valuation of those profits – the price-to-earnings ratio – came back down. Share prices rose, but more slowly. Once optimism kicked in, valuations drove more rapid price rises again, until it became clear that sluggish profits presaged a fall, when despair started over.

There are other ways to classify the cycle, but as ever the problem is applying the model. Clearly despair and hope followed each other quickly in 2008 and 2009. Mr Oppenheimer puts 2010-11 back in despair thanks to fears of euro break-up, which would suggest the gain of a fifth in eurozone shares this year was a new hope cycle. On this basis, prepare for slower but still acceptable share gains.

Apply the pattern to the US and it looks very different. The growth phase involved a hefty correction because of the euro crisis, but the basic model held. In the last optimistic phase, Goldman says shares typically return 27 per cent in 14 months, driven by soaring valuations. In the past 12 months the S&P 500 has risen 30 per cent, with a 23 per cent rise in the forward PE ratio.

Bears can add this to their evidence of excessive optimism. Bulls must hope global economic growth will push up sales (US profit margins surely can rise no further), confirming a long “growth” phase. As always, no two cycles are enough alike to make it easy.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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