or earnings? Only one matters
SCMP April 20
the world dangerously obsessed with stock prices as a measure of prosperity
posing the question, I am not referring to the harmless daily habit
of following the prices of one's own investments in the same way as
the football scores. Nor even am I thinking of the "buy, buy buy" hype
that characterizes the markets coverage offered by the business TV channels.
is genuinely worrying is that the obsession seems to have reached those
people who ought to least impressed by the ups and downs of stock prices,
the guardians of sound money, the central bankers.
set a poor example with its massive intervention in 1998, presented,
not entirely honestly, as a defence of the currency peg. The buying
spree looked clever enough at the time. Without it the Hang Seng index
might well have fallen to 5,000. But the subsequent unwinding of this
purchase of 10% of the Hang Seng index has been one reason why Hongkong's
economic recovery, as well as its stock index, has lagged the rest of
Asia. Meanwhile it cushioned Hongkong from the kind of shock needed
to generate change. Hongkong now looks more like a static Japan than
a reviving Korea.
latest official - and stockmarket hope - is that mainland money will
come to rescue as Hongkong is given the benefit of China's first steps
to liberalize portfolio capital outflow via qualified institutions.
Hongkong should be discouraging this. Firstly it should, if it wants
to maintain its international status, never consciously seek special
privileges from the mainland. Equally it should never suggest to the
still mostly impoverished mainland that it has any obligation to give
Hongkong any breaks.
a move is also likely to be contrary to the interests of most mainlanders.
They are likely to be more interested in H shares than in traditional
Hongkong counters, property and banks. Yet only a few privileged institutions
will have access to the relatively cheap H shares. Most Chinese will
continue to have to have access only to much more expensive A shares
of the same companies. Existing H shares holders - myself included -
will likely profit yet again at the expense of mainland counterparts.
Gradual liberalization of capital outflow is a good idea but giving
a special privilege to Hongkong is bad for both. It looks like another
short-sighted prop to Hongkong.
to the issue of central banks and stock prices, HK Monetary Authority
boss Joseph Yam can now claim that he is not alone in using stock intervention
as a new tool of central bankers. Nor is he just in the company of authorities
such as those in Taipei which have often and blatantly intervened in
the market for political purposes. No. The alarming indications that
central bankers should concern themselves with stock prices has come
from the west's own leading central bankers.
has come to light that the US Federal Reserve recently considered the
use of "unconventional" measures to boost confidence and the stockmarket
in the event that last year's dramatic cuts in interest rates failed
to have the desired result. Those prospective measures undoubtedly included
intervention in the stockmarket. Indeed it remains possible that the
Fed did indirectly intervene through the derivatives markets.
that possibility is unsettling enough, even more remarkable was the
suggestion from none other than the president of Germany's Bundesbank
that it might sell some gold and re-invest in a portfolio of European
equities. To cap it all, the European Central Bank head Wim Duisenberg
suggested that there was nothing "unusual" about central banks buying
equities. So from the conservative heart of Europe, land of cautious
money growth and tight restraints on inflation and fiscal deficits,
comes apparent support for yet more moral hazard.
are several things which are highly objectionable about this proposition.
In the first place, central banks are not investment funds. Their assets
are there to influence interest rates and the exchange rate, to ensure
stable and appropriate monetary growth. Gold is a monetary asset not
a normal commodity or earning investment. (The Hongkong government could
make a case for investing some of its fiscal reserves in equities but
only if it divorces its fiscal reserves management from monetary management
and exchange rate defence).
the inclination of the central banks is clearly always to intervene
to prevent prices falling. Have they ever been known to intervene directly
to deflate bubbles? Intervention is inevitably asymmetric. Anyway, who
are they to determine the correct level of specific asset prices?
central bankers have plenty of monetary instruments to regulate the
growth of credit, and tools such as margin requirements to influence
lending to specific sectors such as stocks and housing. They should
stick to these. The argument that falling stock prices is bad for consumer
confidence may be half true. But it exhibits the sort of short term
thinking that central bankers are supposed to avoid and which has made
profit manipulation so widespread.
was exhibited in extreme form by Enron and Arthur Andersen but even
companies as illustrious as IBM have engaged in dubious accounting to
inflate profits and beat "analysts' estimates". What matters to us all
as investors is not current stock price levels but the real returns
on capital both now and in the future.
evidence suggests that official desire to prop up share prices has kept
them at levels which are well above reasonable, and historical, long
term earnings and inflation expectations. This is doubly dangerous as
many pension plans in aging societies have come to depend on assumed
capital growth rather than earnings.
real (after allowing for inflation) earnings yield on the S&P index
is currently negative and the prospect for earnings outpacing nominal
GNP growth in the next few years is poor. Use of central banks tools
to prop up asset prices while earnings decline may improve the images
of Messrs Greenspan and Duisenberg but is creating enormous future problems,
especially for countries with fast aging populations.
we need is low asset prices and good returns. Now most markets in the
developed world offer the opposite. Financial asset price inflation
as now deemed good by Greenspan & Co represents a transfer of wealth.
In Hongkong that enabled Richard Li and insiders who got early into
the PCCW ramp to make huge profits at the expense of come-later small
shareholders. Valuation was divorced from recurrent income generating
and investment bankers love high asset prices. The rest of us should