Maybe, just maybe, we have learnt some lessons from the crisis

Allister Heath

IT IS usually a pretty good rule of thumb that nobody really learns anything from booms and busts. The bubble was caused by loose monetary policies, buoyant credit and state subsidies to home-buyers – and we are seeing all of the same again, albeit in supposedly more responsible guise. Just like in the 2000s, falling consumer price inflation – down to 2.2 per cent on the official measure and 2.6 per cent on the retail price index – is being seen as proof that monetary policy can remain loose, even though excessive liquidity usually manifests itself in capital misallocation and asset bubbles these days. We are even seeing echoes of the bubble, with Twitter being ridiculously over-valued.

But it’s not all a case of lemmings jumping off the cliff again. Banks now hold more capital; and governments are trying to introduce resolution mechanisms to deal with bust banks without mugging taxpayers. Even more remarkably, analysts appear to have become much more realistic.

The great problem in the City and in New York is that sell-side equity analysts are far too bullish: they overwhelming issue “buy” notices and very rarely urge a “sell”. In most cases, this is not caused by obvious conflicts of interest (such as an analyst writing supportive research of a company his or her bank is trying to float). Rather, there is a cultural bias, a herd mentality (it is very hard to disagree with everybody else if you are sitting in an office of 6,000 people) and an issue of broad self-interest (analysts and their firms will do better if markets go up).

Even worse, the optimism is correlated with market performance: the higher the stock market, the more optimistic analysts become – and the worst the market does, the more pessimistic they become. In other words, they are exactly wrong: the correct strategy is to buy when everybody thinks the world is about to end and sell when everybody is drunk on irrational exuberance.

On Wall Street, at the time of the peak, no fewer than 73 per cent of all ratings were a buy, according to a fascinating note from Schaeffer’s Trading Floor, which has long tracked this statistic. This fell to a trough of 43 per cent by 2003, before increasing with equities, peaking at over 50 per cent of buys just before the markets collapsed during the financial crisis.

Yet that depressing trend appears to have been smashed, and the mad mania vanquished. Analysts have actually (almost) got it right this time: buys peaked at over 55 per cent by late 2011 and have been falling ever since, inversely to the market’s rise. They are now at about 47 per cent: many analysts believe that US equities are no longer cheap. As Schaeffer points out, nobody has ever seen anything like it – analysts have actually grown more sceptical as the stock market has risen. Maybe, just maybe, Wall Street and the City have learnt another big lesson from the crisis. Psychology is hard to defeat but we can but hope.

Will the Swiss commit economic suicide? Consider the referendum they will be holding on 24 November. The public is being asked whether there should be a law stipulating that the best paid worker in a firm can only earn 12 times more than the lowest paid. If it passes, it would be the most extreme egalitarian, socialist law imposed in any country in the Western world in decades. It would be far more destructive than anything Francois Hollande has come up with.

Companies would relocate or find new ways to pay high earners. With a bit of luck, such an attempt to buck the laws of supply and demand, to negate differences in productivity and to destroy incentives, will be defeated. But the fact that it is even being discussed is yet more evidence of a slow-burn crisis of faith in capitalism that its defenders must urgently address.
Follow me on Twitter: @allisterheath