This is the original version of my latest FT column, and is I suppose the nearest I have been to a unqualified market call for some time (I always bear in mind Galbraith's famous comment that economists forecast "not because they are know, but because they are asked"). My friend Jim Rogers, I see, talks in the latest issue of Barron's about this probably being "a bottom, but not necessarily the bottom", which is about where I come out too. It is far too risky, in any event, to be out of equities at this point.
The view expressed by this column at the start of 2007 was that it would be a good year for professional investors to study how bull markets end and to start preparing for that outcome. That turned out to be not a bad call, even though in the event it was not until the last quarter of the year that the market averages finally peaked and the financial crisis, in all its fury, started to spill over into the real economy.
The challenge for investors now is clearly to try and understand what lessons can be learnt from the way that bear markets bottom out and to prepare for that eventuality instead. After a traumatic first two months of the year, the markets have since caught a new mood of optimism – and there are, increasingly, some solid reasons to believe that this time they may be right to display that optimism.
Most bear markets, intriguingly, seem to display a number of common features. For example, they start out declining at a relatively slow pace and then accelerate. A typical pattern is for two thirds of the overall decline to be concentrated into the final third of the bear market’s duration.While there have been bear markets that last more than 18 months, it is usually unwise – and increasingly risky – to act on the assumption that they will last much longer than that.
The reason is that the risks of missing out on what is often a rapid recovery in the first stages of a new bull market soon begins to outweigh the risk of further falls in the ageing bear market that preceded it. The scramble by underinvested professional investors to get back into stocks is one of the engines that typically then drives the equity markets back up to a higher level.
If you believe in these two simple metrics, the current bear market is acting true to form. The S&P 500 index, for example, peaked precisely 18 months ago, at 1565. Eleven and a half months later, in late August 2008, it had fallen to around 1200, a decline of just over 20%. From then until its recent low, at 676, it has fallen a further 44%. The Dow Jones index peaked a month later than the S&P index, but has followed a broadly similar pattern since, as has the MSCI World index.
From peak to trough, the US money manager Ken Fisher points out, it is unusual for the monthly rate of decline in the market averages during a bear market to exceed 2.5% to 3%. At the time of the lows in early March, the S&P 500 index had fallen at a rate of more than 3.5% since its peak in the autumn of 2007. This seems to imply that the risk of the market falling through its March lows any time soon is now relatively slim. It is certainly consistent with the view that equity markets were horribly oversold at the end of February.
Of course historical precedents are made to be broken, and there are big differences in the regulatory, political and corporate environment compared to that which prevailed during the great bear markets of the past. Nevertheless the historical experience cannot be ignored. Russell Napier’s in-depth study of the four most extreme bear market bottoms in 20th century history (1921, 1932, 1949 and 1982) throws up further interesting pointers to what might be happening today.
His thesis is that the engine which drives bear markets to extreme lows is the fear of deflation. Once that threat recedes, or at least is no longer perceived to be real, it creates the conditions in which equity markets can recover. They typically won’t do so until (or unless) corporate bonds and commodity prices also improve. In the modern era, it is logical also to expect that the receding threat of deflation will be reflected in the price of index-linked Government bonds and other measures of inflationary expectations.
In recent weeks all three of these market indicators have started to move in the right direction. While that does not prove that the bear market has ended, it is certainly not inconsistent with such an outcome. It provides the clearest of warning signs to the professional community that being out of the market is indeed becoming a significant risk for those willing to assume equity risk.
It is worth emphasising that the bear markets under discussion are medium rather than long term cycles. Mr Napier, for example, does not believe that we have seen an end to the long term bear market in equities that began in 2000. He does not expect the current generation’s equivalent of the four great market bottoms of the 20th century to hit for another five years or so, when the great bull market in bonds that began in 1981 finally runs its course and the dollar is abandoned as the world’s reserve currency.
If you thought what has happened so far is bad, in other words, there may well be worse to come. Today’s equity market valuations are still not as low as they typically fall to at the bottom of history’s worst bear market experiences. The issue however is whether there is money to be safely made from equities over the next 18-24 months and on that point, even without a crystal ball, and notwithstanding the huge uncertainties surrounding the real economy, the omens look much more positive than before.
jd@independent-investor.com
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Newsletter Update July 2010
Friday, April 24, 2009
Sunday, April 5, 2009
What Agency Law Has To Say
This is the Court of Appeal judgment I referred to in my Financial Times column today. As a restatement of law nothing could be clearer, nor, I would argue, more pertinent to the debate about the past and future behaviour of the financial services industry.
Does everybody in the financial services industry fully understand the concept of agency law and how it might affect the way they conduct their business and earn their money? The issue could surely not be more pertinent than today, when even the most hardened supporters of capitalism (of which in general I count myself one) have been badly shaken by the unfolding revelations of how the financial world lent and traded its way into the current global mess.
Having confessed to feeling outraged by the recent behaviour of many banks, a prominent barrister of my acquaintance recently sent me a judgment from the Court of Appeal that lays out, with splendid clarity, the principles that the law applies to anyone who acts as – and is paid to be - an agent of another person. The implications should not, one hopes, be lost on anyone who acts for clients in financial services.
The law sets out clear standards by which an agent’s behaviour and remuneration should be judged, and has done so consistently, as this recent judgment makes clear, since as far back as the 19th century. In an ideal world every agent would uphold these principles by choice, not just as a matter of professional and fiduciary duty, let alone because some regulator had told them to do so, but for reasons of personal integrity and observance of the law.
The case in question, on which judgment was handed down last month, concerns the case of a footballer, Trinidad and Tobago’s international goalkeeper at the time, who fell into dispute with his agent after agreeing a move to Dundee United. The world of football agents is one of the murkier areas of modern commercial life, but some might feel that drawing comparisons with the recent behaviour of, say, sub-prime lenders and brokers is no longer as far-fetched as might once have been thought the case.
The agent negotiated a move to Dundee United in return for a 10% cut of the footballer’s salary, but then subsequently agreed a separate, undisclosed, deal with the football club that enabled him also to be paid for arranging a work permit for the player. This second deal was worth £3,000, around £200 less than a full year’s commission on the player’s salary, and several times to true value of work involved in the work permit application.
When the player found out about the agent’s separate deal with the club, he stopped paying the agent his 10% cut and took the matter to law, claiming both the agency fees he had paid and the £3,000 work permit fee as well. (Quite how a dispute involving such small sums managed to travel all the way to the Court of Appeal is an interesting question. As a taxpayer, one has to assume that the courts felt moved to justify the expense by the need, once more, to restate the principles of agency law to a wider audience).
The three judges sitting on the case decided unanimously to find against the agent, and declared that he was not entitled to any of the money that he had earned from either transaction. Their judgment is a brilliant summary of the law’s findings on agency law down the years, starting with the landmark case of Boston Deep Sea Fishing v Ansell (1888) and three further important cases in 1903, 1923 and 1925. Of these, perhaps to nobody’s surprise, two involved estate agents and the third revolved around the sale of mineral rights in the Forest of Dean.
In the latter case, one of several magisterial precedents on which the Court of Appeal relied for its recent judgment, Lord Justice Scrutton laid down the law as follows: “An agent must not take remuneration from the other side without both disclosure to and consent from his principal. If he does take such remuneration he acts so adversely to this employer that he forfeits all remuneration from the employer, although the employer takes the benefit and has not suffered a loss by it”. In another case Lord Atkin, better known for a famous judgment on negiligence, said the courts always maintained “a very high standard of conduct on the part of agents”, and did so in part because the standards were often broken, “not by honourable men in commerce, but by a great many men engaged in mercantile transactions”.
Lord Justice Jacob, in the most recent case, pronounced as follows: “The law imposes on agents high standards....If you undertake to act for a man, you must act 100% body and soul for him. You must act as if you were him. Your must not allow your own interest to get in the way without telling him. An undisclosed but realistic possibility of a conflict of interest is a breach of your duty of good faith to your client”.
If the principles of agency law are not today well known today in the financial world, it is probably time that they were. The one common theme that runs through the successive judgments cited by the Court of Appeal is that the principles of an agent’s duty cannot be repeated too often. As Lord Justice Scrutton concluded in the 1923 mineral rights case: “I hope it [agency law] is thoroughly understood in London; and if it is not thoroughly understood in the Forest of Dean, then the sooner it is understood there the better”. Today he might, alas, feel moved to reverse the geography, but not the sentiment.
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Does everybody in the financial services industry fully understand the concept of agency law and how it might affect the way they conduct their business and earn their money? The issue could surely not be more pertinent than today, when even the most hardened supporters of capitalism (of which in general I count myself one) have been badly shaken by the unfolding revelations of how the financial world lent and traded its way into the current global mess.
Having confessed to feeling outraged by the recent behaviour of many banks, a prominent barrister of my acquaintance recently sent me a judgment from the Court of Appeal that lays out, with splendid clarity, the principles that the law applies to anyone who acts as – and is paid to be - an agent of another person. The implications should not, one hopes, be lost on anyone who acts for clients in financial services.
The law sets out clear standards by which an agent’s behaviour and remuneration should be judged, and has done so consistently, as this recent judgment makes clear, since as far back as the 19th century. In an ideal world every agent would uphold these principles by choice, not just as a matter of professional and fiduciary duty, let alone because some regulator had told them to do so, but for reasons of personal integrity and observance of the law.
The case in question, on which judgment was handed down last month, concerns the case of a footballer, Trinidad and Tobago’s international goalkeeper at the time, who fell into dispute with his agent after agreeing a move to Dundee United. The world of football agents is one of the murkier areas of modern commercial life, but some might feel that drawing comparisons with the recent behaviour of, say, sub-prime lenders and brokers is no longer as far-fetched as might once have been thought the case.
The agent negotiated a move to Dundee United in return for a 10% cut of the footballer’s salary, but then subsequently agreed a separate, undisclosed, deal with the football club that enabled him also to be paid for arranging a work permit for the player. This second deal was worth £3,000, around £200 less than a full year’s commission on the player’s salary, and several times to true value of work involved in the work permit application.
When the player found out about the agent’s separate deal with the club, he stopped paying the agent his 10% cut and took the matter to law, claiming both the agency fees he had paid and the £3,000 work permit fee as well. (Quite how a dispute involving such small sums managed to travel all the way to the Court of Appeal is an interesting question. As a taxpayer, one has to assume that the courts felt moved to justify the expense by the need, once more, to restate the principles of agency law to a wider audience).
The three judges sitting on the case decided unanimously to find against the agent, and declared that he was not entitled to any of the money that he had earned from either transaction. Their judgment is a brilliant summary of the law’s findings on agency law down the years, starting with the landmark case of Boston Deep Sea Fishing v Ansell (1888) and three further important cases in 1903, 1923 and 1925. Of these, perhaps to nobody’s surprise, two involved estate agents and the third revolved around the sale of mineral rights in the Forest of Dean.
In the latter case, one of several magisterial precedents on which the Court of Appeal relied for its recent judgment, Lord Justice Scrutton laid down the law as follows: “An agent must not take remuneration from the other side without both disclosure to and consent from his principal. If he does take such remuneration he acts so adversely to this employer that he forfeits all remuneration from the employer, although the employer takes the benefit and has not suffered a loss by it”. In another case Lord Atkin, better known for a famous judgment on negiligence, said the courts always maintained “a very high standard of conduct on the part of agents”, and did so in part because the standards were often broken, “not by honourable men in commerce, but by a great many men engaged in mercantile transactions”.
Lord Justice Jacob, in the most recent case, pronounced as follows: “The law imposes on agents high standards....If you undertake to act for a man, you must act 100% body and soul for him. You must act as if you were him. Your must not allow your own interest to get in the way without telling him. An undisclosed but realistic possibility of a conflict of interest is a breach of your duty of good faith to your client”.
If the principles of agency law are not today well known today in the financial world, it is probably time that they were. The one common theme that runs through the successive judgments cited by the Court of Appeal is that the principles of an agent’s duty cannot be repeated too often. As Lord Justice Scrutton concluded in the 1923 mineral rights case: “I hope it [agency law] is thoroughly understood in London; and if it is not thoroughly understood in the Forest of Dean, then the sooner it is understood there the better”. Today he might, alas, feel moved to reverse the geography, but not the sentiment.
Read more...
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