Shouldn’t the stock market track the real economy?

Updated 27 February 2013
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Shouldn’t the stock market track the real economy?

2012 turned out to be a very different year than most had expected. Personally, I was very negative coming into the year, especially toward the European economies, and was more or less right in my predictions on that account. However, I was also very skeptical of the rising stock markets. It turned out I was right on the real economy, but wrong on the stock markets. But shouldn’t the stock market track or follow the real economy?
With 25 years of experience as a trader, market maker and fund manager, I should have known better! The stock market and the economy are, of course, linked but rarely on a strict day-to-day or even month-to-month basis. Most often it is a mismatch between expectations and the current reality, both amplified by the critical element of monetary policy, that produces sentiment and market pricing that diverge from the real economy. This is very evident today in Europe with the seemingly illogical combination of historical highs in both unemployment and stock markets. Stock markets have reached the pre-crisis highs of 2007/2008.
History shows that such divergence has its limits and expiration dates — either the economy improves dramatically or markets will need to adjust their expectations lower. To grasp such divergences in a historical perspective, it is useful to look at the difference between broad stock indices like the MSCI World and the German IFO. In 2013, the divergence between the underlying weak economic performance as measured by this survey and the stock market has reached the extremes of levels prevailing before markets crashed in 2000. Hardly a good sign, but remember that the difference can be reduced two ways: stocks dropping or the economy improving.
Fundamentally, the stock market is a “sub-component” of the entire economy, or GDP. Therefore, stocks must correspond to some degree with the rise and fall of the economy and relative to other economic factors like inflation and productivity. A long-term bull market in stocks usually coincides not only with economic growth, but increased productivity and risk premiums. Even more importantly, a real bull market makes everyone benefit, rich and poor, through lower unemployment, productivity and investment — all of which are failing in this present run-up in prices.
So how do investors deal with such an investment conundrum? Ironically, to the well-placed investor all the above technical economic understanding does not really matter. Experience shows that an investor willing to risk holding illiquid assets is rewarded with a risk premium for taking on that risk. The risk premium fluctuates based on inflation, current interest rates and income through dividends from a given stock. Stocks must give a higher yield than bonds to compensate for their inferior liquidity.
When European Central Bank President Mario Draghi in July 2012 ensured the world that he would do “whatever it takes” to keep the euro alive, he created a massive move into more illiquid assets by removing the presumed negative potential in bonds and hence indirectly fuelling stocks. But again — as investors, we do not need to understand this. If we follow simple rules, we do not need to mix our analysis of the real economy with stock pricing. We can be economic agnostics.
In the 1970s, the American investor Harry Browne crafted the so-called Permanent Portfolio. Its logic is very simple. Invest 25 percent in each of four different assets: stocks, long government bonds, metals and cash. Sounds boring? From 1972 to 2011, the yield from such an allocation has been 9.5 percent. In real terms, no less than 4.9 percent. A much higher yield than the stock market and with a significantly lower risk! An investment of $ 10,000 in 1972 would have grown to $ 377,193 by 2012.
This does not mean that active trading does not pay off, but works to illustrate that it wise to always have a “dumb model” as a backstop or frame of reference. Extra risk or changes in allocation should only be taken when one has an “edge” or strong indicators of being right! The famous hedge fund manager Ray Dalio from Bridgewater has expanded the idea into his All Weather Model. As the name suggests, it is designed to handle any economic condition. The results have been very convincing. Since 1996, the annual yield has been approximately 12 percent, turning Bridgewater into the world’s largest fund with $ 141 billion under management.
The difference between the two is that Harry Brown allocates assets while Ray Dalio and Bridgewater allocate risk. What they hold in common is a total agnostic attitude towards the market. They accept the very important premises of trading: We do not know what tomorrow brings; we do not know where we are going and we will get our yield primarily from extracting the risk premium from assets. The beauty of all this is that we do not have to understand the relationship between the economy and stock markets to invest efficiently. Considering the current unpredictable macroeconomic interventions, such an approach should offer a huge relief from trying to understand everything that is going on, and possibly an advantage to any investor who does not have direct access to the minds of powerful policymakers and central bankers.
As I mentioned above, an investor should only depart from this route if he has a very strong feeling or belief that something is going to happen. Personally, I allocate 70 percent in an All Weather Model. That helped me to get a decent yield in 2012 even though I was almost 100 percent wrong in my very conservative stock market predictions. I used the remaining 30 percent to insure against Black Swan events or place opportunistic investments. I am presently long-term bullish on Sub-Saharan Africa investments. The answer to the title’s question is that the stock market may diverge from the real economy for a limited period, but this has no impact on the rationally placed investor. Investing is about logic and rationality — not genius. And that’s a good thing for all of us.

— Steen Jakobsen is chief economist at Saxo Bank.


Pace of Saudi Arabia’s private sector sell-off accelerates

Updated 25 April 2018
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Pace of Saudi Arabia’s private sector sell-off accelerates

  • Aim is to increase the private sector contribution to gross domestic product from 40 percent to 65 percent by 2030
  • The NCP said that the privatization program would save the government around SR35 billion.

DUBAI: Saudi Arabia’s ports, hospitals, desalination plants, schools, and even its sports clubs, are among the candidates for early transfer to the private sector in a program that the government hopes will generate up to SR40 billion ($10.6 billion) in revenue over the next two years.
The National Center for Privatization (NCP), the body responsible for implementing the big state sell-off program, released details of its privatization plan after the Council of Economic and Development Affairs, chaired by Crown Prince Mohammed bin Salman, approved the proposals to increase private sector involvement in the economy — a vital part of the Vision 2030 strategy to reduce oil dependency.
The aim is to increase the private sector contribution to gross domestic product from 40 percent to 65 percent by 2030.
The NCP said that the privatization program would save the government around SR35 billion, add SR14 billion to gross domestic product, and generate up to 12,000 new private sector jobs in the Kingdom by 2020 — the initial phase of the sell-off.
“The scale is very realistic given that privatization is a complex and time-consuming process from a host of perspectives, including regulatory, governance and legal,” said John Sfakianakis, director of economic research at the Saudi Arabia-based Gulf Research Center.
“The estimated amount is equally pragmatic at this stage. These numbers change both due to valuations and appetite as well as economic conditioning with time.”
Other parts of the national economy are also earmarked for some form of privatization under the Delivery Plan 2020. Transport, the renewable energy industry and flour mills are all scheduled in an NCP report that lays out the structure and conditions of the state sell-off program.
“The most important characteristic is the commitment to push ahead with privatization as well as do it in a phased way over the next few years that involves a number of different sectors. There is an evolutionary phase to any privatization process that involves multiple phases over time,” said Sfakianakis.
The King Faisal Specialist Hospital and Research Center, the Riyadh facility regarded as the jewel in the crown of Saudi medical facilities, is named as a subject for incorporation as a prelude to becoming a non-profit organization “to become financially independent and a role model in the health sector and help in achieving its leadership position through focusing on innovation.”

HIGHLIGHTS
- The National Center for Privatization hopes the 2020 privatization program will contribute SR13-14 billion to Saudi Arabia’s GDP.
- Total government proceeds from asset asset sales will total between SR 35 billion.
- Net savings (capex and open) from privatization and PPP projects are forecast to be SR25-33 billion.
- Between 10-12,000 new private sector jobs will be created.
- The privatization program aims to enhance competitiveness, and improve the Kingdom’s business environment through privatizing government services.


Other hospitals will be privatized by the handing over of medical facilities to private operators and the creation of new medical cities, as well as primary care facilities, the provision of rehabilitation services, radiology and laboratory
upgrades.
In a statement, Turki Al-Hokail, chief executive of the NCP, identified other sectors that would be the focus of the privatization plan, including agriculture, housing, energy and Hajj and Umrah services.
“The privatization program aims to enhance competitiveness, elevate the quality of service and economic development, and improve the business environment through privatizing government services,” he said.
The privatization program has been an element of the Vision 2030 strategy since it was launched two years ago, but the latest document sets out a firmer timetable for the sell-off. It identifies “game changers” — businesses that will “receive special attention from the leadership to ensure their successful completion.”
The first three “game changers” are Saudi Arabian ports, the Saline Water Conversion Company at Das Al-Khair and what the NCP calls “opportunity explorers” — structures aimed at facilitating partnership opportunities between the public and private sectors.
The NCP makes clear it is keeping its options open in choosing what kind of privatization is appropriate for a sector: “Full or partial asset sale, initial public offering, management buy-out, concessions or outsourcing” are all under consideration.
Some 100-plus privatization initiatives have been identified across 10 ministries, of which some (including sports clubs, grain silos and desalination) are expected to be completed by 2020.
Jason Tuvey, Middle East economist at Capital Economics, said that the estimate of selloffs were lower than what was possible given the “vast number” of companies that the Saudi state wholly owns or has a controlling stake in.
“Excluding the Aramco IPO, we’ve previously estimated that the government could raise around $25-50 billion from privatizations,” he told Arab News.
The document also makes clear that foreign participation will be allowed in some parts of the program.
The NCP program does not include any assets owned by the Public Investment Fund, the body which is intended to become the world’s largest sovereign wealth fund with assets of $2 trillion by 2030 and which will retain the right to sell the assets it owns in partnership with the government.
The NCP program also does not include residential real estate assets which are unlocked for private sector usage by contractors and real estate developers, and which are covered by the national housing program.
Ministers have said that the overall privatization program could raise as much as $200 billion in sell-of proceeds in the years running up to 2030, but there is no certainty as to how that figure will be reached. In Riyadh last week government officials gave a more conservative estimate of between $50 and $60 billion.
The plan also makes it clear that there is still work to do on the legislative and regulatory framework within which privatization will be pursued. The first of the three “strategic pillars” of the Delivery Plan is the creation of such structures “to enable privatization processes and governance by setting clear and specific procedures that increase the level of preparation and execution of privatization.” Key initiatives remain to be fulfilled in this respect, the document says.
Al-Hokail added: “The privatization program is in the interests of Saudi citizens, will bring many benefits, and improve the investment climate. The program’s strong governance foundation will be a strong pull factor for global investors and large corporations because it sets the guidelines that will make the program attractive.”