In 300 BCE, Euclid developed the concept of mathematical “proofs” using deductive reasoning to uncover truth. Several thousand years later, in his search for economic truth, Grant Williams, portfolio manager and strategy adviser for Singapore-based Vulpes Investment Management, laid out four mathematical “proofs” at the 66th CFA Institute Annual Conference that address the disconnects and incongruities between financial markets and the global economy.
Problem #1: If we have a global economy that is barely growing, why are major equity markets hitting all-time highs?
With the global economy limping along at 1.4% growth, Williams identified the disconnects between the underlying fundamentals and equity prices in major countries. Manufacturing and trade indicators (in the United States, the eurozone, United Kingdom, Japan, and China) are stalling, including the Purchasing Managers’ Index (PMI), the Baltic Dry Index, and the U.S. Macro Index. About 25% of companies in the S&P 500 missed earnings forecasts in the first quarter of 2013; 45% missed in Europe. But even more disturbingly, 45% of companies in the United States and 66% in Europe missed their revenue targets. Williams also cautioned the audience about valuation levels. Although, admittedly, we’re not back up to dot com–era levels, it would still require a 30% drop in the current Shiller P/E ratio of 24x earnings to get back to the ratio’s 130-year historical average of 16x. “Also, real bull markets start at about 5–7x earnings,” Williams noted.
Problem #2: If China’s manufacturing sector has stalled, how will China grow at 7.7%?
Demand for raw materials in China is slumping: PMI, iron ore prices, and copper product imports are all on a downward trend. Imports and exports are declining, and Chinese power consumption is falling. “China’s published GDP data for 31 provinces is, shall we say, ‘questionable,’” said Williams. And the sum of the provinces does not add up to the total reported GDP. He also noted that it only takes two weeks to report China’s GDP, whereas the United States takes eight weeks and the data get several revisions. Even Hong Kong takes six weeks. Unless you think China is significantly more efficient in its calculations, the timing alone makes the numbers suspect.
Problem #3: How can France realistically still be considered one of the “bailers-out” in the eurozone?
Now led by President François Hollande of the Socialist Party, France is feeling the weight of its public sector spending, currently 56% of GDP. Williams noted that the French leadership seems out of touch with economic reality, citing Hollande’s actions to reduce the retirement age from 62 to 60 and impose a 75% tax on millionaires. “French film star Gérard Depardieu was even driven to seek a better life in Russia!” exclaimed Williams. In addition, production and consumption has fallen off dramatically in France, and unemployment stands at 10.7%, the highest rate in 15 years, with youth unemployment checking in at more than 26%. France has never had a good record of reining in spending, and the last time the country had a balanced budget was 1974. Hollande has said he doesn’t believe in austerity, and France missed its own budget target in 2012 when the deficit hit 4.8% of GDP.
“You know there are dozens of famous French philosophers who have contemplated life’s issues, but can you think of one well-known French economist?” Williams quipped. Still, with all this bad news, the 10-year French bond yield is at a 250-year low of around 2%. France is ill-equipped to fund the rest of Europe, so that leaves only Germany to bail the others out, Williams said.
Problem #4: Why does the gold price not equal the price of gold?
The laws of mathematics apply to gold. As a long-time precious metals investor, Williams said, “Gold is an emotional asset and there’s no other way to value it, except emotionally. It’s your comfort level with every other investment.” He took the audience through his analysis of the disconnect between the gold price (on paper) and the price of gold (the physical one, which Williams said is the more important indicator to watch). He also discussed the unprecedented declines in the gold price on 12 April and 15 April 2013 that turned out to be an odd, 8-sigma event.
Using Math to Invest for the Long Term
In his search for truth, Williams casts a skeptical eye on policymakers and told the audience why he believes attempts are being made by central banks “to subvert the age-old laws of mathematics that would restrict them from maintaining the status quo.” In the short term, central banks have corrupted the risk-free rate, forced investors into risky assets, and suppressed volatility.
But the laws of mathematics cannot be subverted over the long term, Williams asserted. Investors who have patience and a long time horizon can take advantage of the disconnects because the natural order will eventually prevail. And he contended, as he often does on his popular website, Things That Make You Go Hmmm…, that “if something doesn’t make sense, chances are it’s nonsense and should be treated as such.”
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