Market View - October 2009

Thankfully we did not need to heed the ides of September as some had feared with its reputation as one of the worst months historically for the US stock market.

However towards the end of the month, we saw a bit of a wobble in both global equities and commodities, leading to the $64 million question once more of can the bull market in stocks continue? The long summer rally has seen global stock markets climb more than 50% (and in some cases e.g. Emerging Asia substantially more) since the lows of March, but the decision of some of the key western central banks to begin scaling back the supportive stimulus packages from this month has made some commentators nervous of the implications, especially as so much economic and fundamental data remain weak.

Caution would appear to be the watchword as we move from one historically feared month for market volatility to another, namely October. However to quote the man whom many regard as the world's most successful investor, Warren Buffet, "If past history was all there was to the game, the richest people would be librarians"

During September the S&P 500 climbed steadily from 1020.62 to an intra month closing high of 1071.66 before falling back to 1057.08 at month end. The FTSE 100 meanwhile went from 4819.70 during the month to 5172.89, before falling back to 5133.90 (source, ft.com).

A surprise drop in the sale of consumer goods for August added to market concerns about the fragility of the global recovery, while the outlook for the both the US dollar, which recently hit a one year low against the Euro, and Sterling (at a 5 month low versus the Euro) continued to look gloomy with the latter's demise contributed to by the Bank of England Governor Mervyn King's statement that a weaker pound would help British exports. Contributing to negative sentiment surrounding the Dollar is the $7 Trillion of bonds issued by the US Government this fiscal year, and there can be little doubt that the price of gold bullion which recently surged through $1000 an ounce has been a major beneficiary with investors concerned about future inflationary risks.

While having some gold in our portfolios as a hedging strategy undoubtedly makes sense, it is questionable how attractive holding the yellow metal is now compared to the start of the decade when the commodity bull market began in earnest and bullion was priced below $300 an ounce. Interestingly while many market commentators understandably look at conventional market valuations such as historic price earnings (PE), forecast PE's, dividend yields etc., to determine how expensive or cheap the market is, it can also make sense to compare the market's value in gold terms.

If we take the price of gold and the price of the US market as measured by the Dow Jones Industrials Average (DJIA) over the past 40 or so years, we can see that back in January 1980, not long before the start of one of the greatest bull markets in stock market history, stock prices (with hindsight) were cheap, and one ounce of gold at approximately $800 would have bought you 1 unit of the DJIA which also traded at around 800 at that time. However by the time the US market peaked at the top of the dot.com mania, on the 14th January 2000, the DJIA was trading at 11,722 while gold bullion was $283 an ounce (source, Bloomberg).

Effectively you needed 41 ounces of gold to buy just one unit of the US stock market at the top of the dot.com equity bull market, showing clearly (at least with hindsight!!) that either stocks were vastly over valued or that gold was incredibly cheap, or indeed as it turned out a combination of both! Fast forward to March this year when the DJIA closed at 6547 on the 9th which turned out to be the market bottom, and gold closed at $923, giving a ratio of just 7 to 1, it again becomes clear that stocks were probably cheap on a gold valuation basis.

Now the DJIA is close to 10,000 again while gold is closer to 1,000, suggesting that while stocks are not as cheap as they undoubtedly were in 1980, or indeed six months ago, the ratio of 10 gold ounces to 1 unit of the DJIA is not compellingly expensive, and indeed is a reason sighted by many commentators for why this rally could have a long way to go yet!