One day last week, my screen of daily global stock market price indices was a sea of green as every price was up. India touched an all-time high a month ago, earlier this month it was Australia and last week the EuroStoxx 600, the US S&P 500, Taiwan and Japan all breached all-time highs.
I remember Japan’s last high in 1989, when shares and the yen both doubled in four years. A pizza in Roppongi cost more than US$50.
Lesson One of investment is that what goes up in a surge of narrative often comes down sharply as the strands of the narrative mutate into more realistic assessments of the events. The Nikkei index plummeted 56 per cent in the next four years and only levelled off 20 years later, more than 80 per cent below the high.
Lesson Two for global investors is that currency is like the paper on which a great master’s work is painted – it is fundamental to valuations. Unsurprisingly, the recently soaring Japanese stock market has been helped by the significant fall in the yen.
Totally green screens are a rare occurrence because most days at least one market somewhere in the world spoils the pattern. Today’s risk-on dominant market narratives driving price rises include the artificial intelligence bubble, the proven strength of the global consumer, stable inflation and interest rates, and the government spending windfall during the Covid-19 pandemic.
Floor traders jostle on January 7, 1988, as stock prices soar on the Tokyo Stock Exchange following the sharp rise in the yen against the US dollar, pushing the main market indicators to record levels. Some 35 years after Japan’s asset bubble catastrophically burst in the early 1990s, the Nikkei 225 finally clawed its way back above its bubble-era record on February 22, but this time many ordinary investors are driven more by concerns about savings and pensions than coveting fine art and penthouses. Photo: AFP
These all-time highs remind me of the lessons I learned running European investment portfolios in 1990. It was a Goldilocks time because the Berlin Wall had just fallen and the narrative of the reunification of Germany had caused a surge in the then-nascent German market. Share prices rose steadily across two years before a repeat of Lesson One saw the German DAX index fall by a third in 1990.
Lesson Three is the “rule of thirds”, as, based on my observations, markets often react to a big move by reversing a third of the original amount.
Lesson Four was learned when the markets bottomed out just after the reunification narrative made a comeback in 1992. I noted that the markets reverse direction every three or four quarters, perhaps at the end of month and especially at the end of the year. I have since termed this indicator Harris’ Law of Quarterly Reversals.
By the end of May 1992 – you guessed it, the market was up by a third. History does not exactly repeat itself, but it can rhyme in tune with similar situations in the past. It will not exactly repeat, though, because of the different strength and timing of new market narratives. Lesson One was relearned as the market fell by nearly a quarter between May and October 1992.
Lesson Five was that in a volatile market such as Germany, which at the time was still an emerging stock market destination, it is easy to get whiplashed. The trend is not your friend as the narratives reverse too fast for investors to make money. I decided to visit Germany to investigate whether the good times were over by speaking to local companies and analysts.
A statue of a bull is silhouetted outside the stock exchange in Frankfurt, Germany. Photo: Reuters
I had previously rented a large hammer from an East German entrepreneur for US$5 to strike a blow on the Berlin Wall itself. This time I went to Munich, which happily coincided with the 1992 Oktoberfest (investors should always mix business with reviewing investment data from alternative sources).
During the conference, a confident German analyst said that the market would turn round and go up from here. How we laughed at him! It was around the end of the month and he was dead right.
Lesson Six taught me that market movements significantly lead economic indicators and that investors should be contrarian and be ready for the unexpected.
In keeping with the lessons so far, the market rose by nearly two-thirds (Lesson Three). It peaked nicely on the first day of trading in 1994 (Lesson Four), within a shade of the all-time high from 1990 (Lesson Six) and outperformed the S&P 500 (Lesson Three). Every stock in my portfolio was up, most up a quarter and some by more than 50 per cent.
Lesson Seven is to be careful what you wish for; when everything is green, it is a warning sign rather than a cause for celebration. At that moment, my boss Robert Thomas reminded me that in investment, pride goes before a fall. An important lesson, but fortunately the next three years were relatively stable as the volatility shock of German reunification had taken four years to work through the system.
Lesson Eight says that narrative shocks cause market volatility, but once the financial system has adapted to the waves of narrative disruption, relative calm is restored until the next shock upsets the steady state – and that could take a while.
These lessons are derived from my experience and are still valid today. Shanghai and Hong Kong are missing from the all-time high party as they last peaked in 2007 and 2018, respectively.
Lesson Nine is the reversal of Lesson One – what goes down will eventually start to come up – and that is why I made the call that Hong Kong was through the worst and it was time to buy.
Dr Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, writer and broadcaster, and financial expert witness
