Clichés revisited

In Gustave Flaubert’s delicious Dictionary of Received Ideas, winters “are always exceptional”, cypress trees “only grow in cemeteries”, budgets “are never balanced”, stockbrokers “are all thieves” and imbeciles “are those that do not think like you do”.

While these definitions with their popular edge date back to the second part of the 19th century, they are surprisingly relevant today (the longevity of clichés…). The writer’s vision of the stockmarket is nevertheless an exception since the proposed definition was “a thermometer of pubic opinion”. With a 15% increase on the CAC40 during 2013 whereas unemployment has yet to fall back and the French government’s popularity levels have reached record lows, we can confirm that this stockmarket year seriously undermines the short-cut proposed by Gustave Flaubert.

If the stockmarket is no longer a “thermometer of public opinion” it remains to be seen what temperature it does measure today. Contrary to a(nother) received idea, the stockmarket is clearly not a good indicator of growth in gross domestic product (GDP): activity in Europe has contracted/stagnated over the past two years and yet the Euro Stoxx 50 is riding high… As such, prior knowledge of national or even global GDP growth rates does not shed much light on the investment process.

Is the stockmarket a reflection of growth in corporate earnings? This is probably closer to the reality: the recent curve on the S&P index seems to be well correlated with US company profits. The index has gained 165% since its low point of 2009 whereas company profits have multiplied by 2.3. But here again, the European case stands out: 2012 and 2013 were both excellent stockmarket years showing a combined increase of 30%, but nevertheless correspond to two years of stagnating company profits.

Modern financial markets have become very dependent on each other and are open to a multitude of factors. Seeking a unique explicative variable is now attempting the impossible albeit not without interest. Knowing that GDP or corporate price earnings ratios (P/Es) are not good prediction variables is already a means of trying to avoid “reflex,actions” that are unfortunate for investors. During this intense period of publications for 2014 stockmarket predictions, this “enlightened paranoia” is precious. It enables us to delight in the likely acceleration in earnings growth for companies in the Euro Stoxx 50 (the consensus now stands at around +18%) while bearing in mind that this is not a sufficient factor for guaranteeing growth in the European index in 2014.

In the “it is/it isn’t” game, the negative part is clearly the most obvious to identify. In the case of the stockmarket, “it isn’t” a derivative of public opinion, “it isn’t” a derivative of growth, or even a derivative of corporate earnings growth. Aiming to confine it to one definition is a guarantee of disappointment. However, this fact should not prevent us from continuing to find and read macro-economic scenarios. While these are probably not capable of predicting the future, they have the merit of provoking reflection and telling us a lot about forthcoming flows. As Warren Buffet said so well: “Forecasts tell us nothing about the future, but a lot about those making them”.

What others do around the world… what if that was the stockmarket temperature?

Marc Craquelin