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Don’t say “it’s the same old story” when the statistics prove otherwise. Octobers only stick in our memory of stock markets because the 1929 and 1987 crises are impossible to forget. The Lehman Brothers bankruptcy and subsequent volatility in October 2008 did nothing to enhance the poor reputation of a trading month that has actually generated a positive return of around 1% over the last 44 years2. October is not a bad month for stock markets; it is an overly volatile month.

10 years after the major crash of 2008, October 2018 (when the S&P 500 lost 7%) once again crystallised the concerns of investors who no longer see corporate earnings as an escape from economic and political conditions that are hard to interpret and therefore to anticipate.

We will let the specialists quibble over political uncertainty, as we are in no position to predict how voters and their elected officials will act.

Instead we shall concentrate on the performance of bond markets, which are still the best indicator for assessing investors’ future behaviour. An important event occurred in the United States, where yields on 10-year government bonds – the world’s most liquid investment – broke and settled above the 3% mark. A “risk-free” return on global savings had not been seen at this level since 2011.

This development, which failed to make the headlines, is key to understanding the future of asset prices, and of the stock market in particular. This level of 3% confirms the end of quantitative easing in the United States, after an extraordinary period that will go down in economic history as one of free credit.

This infamous QE policy pursued by all major central banks since 2009/2010 distorted the price of assets, breaking traditional valuation criteria: when risk-free interest rates are zero, the price of assets expected to “pay” a higher return can be infinite! This rationale, which has been commonplace since 2011, visibly distorted prices, particularly for tangible assets such as art and real estate, but also for listed companies with “visible growth”. In recent months, such companies, including HERMES  in the luxury goods sector and LINDT and CHR HANSEN in the food industry, have reached valuations (11x revenue for HERMES, 50x earnings for LINDT and CHR HANSEN) that will go down in stock market history as the perfect illustration of all these excesses.

We can at least feel reassured that, during this extraordinary period, the behaviour of the key players (central banks, banks, regulators) has remained rational. And although the decline of these overvalued assets is inevitable, we do not agree with the Cassandras who cannot imagine a lasting return on savings in such an environment. As Benjamin Graham rightly said, the future is uncertain. But for the immediate future, all the signs suggest that good times lie ahead for value management.

Didier Le Menestrel

1 Thank God October’s Over! David Ross
2 Seasonal volatility, Editorial, November 2014


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