Anthony Bolton is about as close as the British investment community gets to a well-known “investment sage”. Now semi-retired from Fidelity International, Bolton has a long-term record of Buffet-esque quality - so we should sit up and take note when he says stocks are looking cheap.
And that’s the clear conclusion in his latest FT Money column - although we’d note that it takes Bolton almost 900 words to get there - by way of repeated warnings that he doesn’t like to call turning points in the market; that he can only do so humbly knowing “that second-guessing Mr Market is very difficult”; and that “professional investors have a poor record at predicting the direction of markets, which tend to move in a direction that makes the majority wrong.”
Still, notwithstanding a 300 point rally on the FTSE 100 since Xmas, Bolton declares:
When evaluating the market outlook, there are three things that I focus on and one that I don’t. The one thing that I don’t look at is the economic outlook, as this invariably looks great at tops and horrible at bottoms. In my experience, economic views won’t help you time markets correctly.
The first of the three factors I do look at is how the current situation compares with the historical pattern of bull and bear markets. That is, how long and far we have risen in a bull market and fallen in a bear market. When the time and scale of the rise or fall are both high relative to historical averages, the odds of a change of trend increase.
The second factor is indicators of investment sentiment and behaviour. These include: put/call ratios, the sentiment of advisers, market breadth, volatility, mutual fund cash positions and the exposures of hedge funds. When these indicate extreme pessimism or optimism, it normally pays to bet against them. For example, high volatility often precedes a change of trend.
The third factor is long-term (30-40 year) market valuations, particularly measures such as price-to-book value or free cash flow. Again, when these move outside their normal range, it can signal risk or opportunity.
In my experience, when all three factors confirm each other, the odds are that you are near a turning point. It won’t predict the right day, the right week or even the right month, but it might give you the right quarter. All three factors were aligned in the last quarter of 2008, making me optimistic that 2009 will be a better year for equities.
Related links:
Anthony Bolton: How to spot the market’s turning point - FT Money
