FINANCIAL TIDBITS

Excerpt from Global Investor, by Daniel Bogler, of The Financial Times 10/26/99

Mr. Mike Lenhoff, equity strategist for London-based broker Capel Cure Sharp, analyzed Wall Street’s performance since 1871 against the background of three loosely defined macro-economic price regimes: deflation, such as the years from 1930 to 1933; inflation, such as the 1973-1981 period; and dis-inflation, which has prevailed from 1991 to the present.

The results are unambiguous – it takes dis-inflation for equities to thrive. During periods of deflation there is little economic growth, real bond yields are cripplingly high (though nominal ones may look low), and corporate profits suffer. The upshot is a real return on equities of merely 2.9 percent a year. Accelerating inflation is even worse. Once again there is no real economic growth and on top of that bond yields are rising. Granted, earnings growth looks pretty good, but since there is no underlying growth in GDP, it is of poor quality – all price and no volume. Investors clearly see through this, since in real terms shares fell by 6.6 percent a year on average during inflationary times. So much for the old saw that equities are a hedge against inflation.

Only during periods of dis-inflation is the macro background wholeheartedly positive. There is solid GDP growth, bond yields are falling, corporate profits are advancing rapidly and earnings surprises are persistently positive. Moreover, because inflation is low, the quality of earnings growth is high. This is as good as it gets for stocks and has produced an average real return of 6.4 percent a year. Not surprisingly, this near-ideal mix is likely to push the equity market to an extreme valuation. …The US bull market should remain intact. Investors need only become seriously concerned about a secular bear market if inflation starts to accelerate, or if the economy threatens to slip from little or no inflation to outright deflation.