Editor's Note
Ian McGuganMoneySense Magazine, 1st November 2008
The first time I interviewed Andrew Smithers was in 1998, when most people had written off the British economist as a hopeless pessimist. As the dotcom boom roared ahead, he was doing his best to urge caution. His firm, Smithers & Co. of London, was advising its clients to steer clear of equities.
Back then, Smithers gave me a bleak assessment of what the next decade would hold. He told me that U.S. stocks were so overvalued that they would produce no net returns for investors over the next 10 years. He predicted that before stocks thudded back to reality, several investment banks would be bust.
I’ve thought a lot about Smithers over the past year as, one after another, his predictions have all come true. So I decided to give this renowned bear a call. I wanted someone who could tell me just how bad the current crisis is likely to get. I wanted to know what fresh hell lies ahead.
None, it turns out. Much to my surprise, Smithers sounds nearly upbeat these days. “When bank capital is being destroyed, as it is now, people think real capital is being destroyed,” he says. “It’s not. We still have exactly the same amounts of physical capital and human capital as we did before this crisis began. The capacity of the global economy to grow has not changed.”
Smithers acknowledges that the Federal Reserve has lost control of the U.S. economy and that strong action is needed to correct things—but he’s confident that central banks around the world are on full alert and will scramble to do what is necessary. He believes that fixing the system will probably require governments to invest money directly in banks to recapitalize the system.
Smithers believes the likeliest outcome is a global recession that will last until the middle of 2009, then a return to normal levels of growth by no later than 2011. In other words, we’ll have a garden-variety two-year slowdown, not the depression that the newsmagazines are predicting.
What should investors do? Smithers believes fair value for the S&P 500 is just below 900, about 10% below where it stands at press time. But he cautions that markets have a habit of overshooting fair value in both directions. The classic pattern would be for stocks to fall a third below fair value before they begin a sustained recovery. For the next year or so, he believes that keeping money in the bank would be a fine idea. “If you do that,” he says, “the risk you run is that the market will be substantially higher in six or nine months than it is now and you will have missed an opportunity. But based upon history, you face a far greater risk that the market will be substantially lower in that period.” If you’re in the market for the long haul, you may not want to budge at all. “The market is not yet cheap, but it is reasonably priced compared to what we saw a decade ago,” he says. “If you’re holding for the long-term, you will get a reasonable return.”
It’s a modest forecast, but one that makes me feel much better. When one of the world’s most thoughtful pessimists tells you that the future’s not so bad, it may be time to start turning optimistic.
Ian McGugan
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