With worries about Greek exit from the eurozone, with the unlikelihood of further quantitative easing in the USA and the UK, with interest rates likely to rise in the medium term, and with Chinese growth predicted to be more moderate, many market analysts are forecasting that stock markets are likely to fall in the near future. Indeed, markets are already down over the past few weeks. Since late April/early May, the FTSE is down 4.5%; the German DAX index is down 7.0%; the French CAC40 index is down 6.9%; and the US Dow Jones index is down 2.3%. But does this give us an indication of what is likely to happen over the coming months?
If stock markets were perfectly efficient, then all possible information about the future will already have been taken into account and will all be reflected in current share prices. It would be impossible to ‘get ahead of the game’.
It is only if market participants have imperfect information and if you have better information than other people that you can are likely to predict correctly what will happen. Even then, the markets might be buffeted by random and hence unpredictable shocks.
Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.
If Greece were definitely to exit the euro, if interest rates were definitely to rise in the near future, if it became generally believed that stock markets were overvalued, then stock markets would probably fall. But these things may not happen. After all, people have been predicting a rise in interest rates from their ultra-low levels for many months – and it hasn’t happened yet, and may not happen for some time to come – but it may!
If you want to buy shares, you might just as well buy them at random – or randomly sell any you already have. As Tetlock says, quoted in the Nasdaq article:
“Even the most astute observers will fail to outperform random prediction generators – the functional equivalent of dart-throwing chimps.”
And yet, people do believe that they can predict what is going to happen to stock markets – if not precisely, then at least roughly. Are they deluded, or can looking calmly at likely political and economic events put them one step ahead of other people who perhaps behave more reactively and emotionally?
Bond rout spells disaster for stock markets as global credit kraken awakens The Telegraph, John Ficenec (14/6/15)
Comment: Many imponderables for markets The Scotsman, Bill Jamieson (14/6/15)
How Ignoring Stock Market Forecasts Will make you a better investor Forbes, Ky Trang Ho (6/6/15)
The Predictions Racket Nasdaq, AdviceIQ, Jason Lina (21/5/15)
Questions
- Why may a return of rising interest rates lead to a ‘meltdown in equity prices’? Why might it not?
- Why have bond yields fallen dramatically since 2008?
- Why are bond yields rising again now and what significance might this have (or have had) for equity markets?
- Why may following the crowd often lead to buying high and selling low?
- Is there an asymmetry between buying and selling behaviour in stock markets?
- Will ignoring stock market forecasts make people better investors?
- “The stock market prices suggest that investors believe both the Federal Reserve and the Bank of England are bluffing about raising interest rates. That may be so, but it is an extremely risky game of chicken for investors to play.” Explain and discuss.
New Look was founded in 1969 and is an iconic budget retailer found on most British high streets. In its history, it has been a family business; it has been listed on the London stock exchange; returned to a private company and then had the potential to be re-listed. Now, it is moving into South African ownership for £780 million.
90% of New Look will now be owned by Christo Wiese who controls Brait and who has been linked with other take-overs of British retailers in recent years. The remaining 10% will remain in the hands of the founding family. The company has been struggling for some time and in 2010 did have plans to relist the company on the London Stock Exchange. However, volatile market conditions meant that this never occurred and the two private equity firms, Apax and Permira, appeared very eager to sell. New Look’s Chairman, Paul Mason, said:
“This is an ideal outcome for New Look. The Brait team demonstrated to us that they have the long-term vision to help Anders and the team grow this brand.”
It is not yet clear what this move will mean for the retailer, New Look, but with an estimated £1 billion debt, it is expected that changes will have to be made. 
It is certainly an attractive investment opportunity and New Look does have a history of high rates of growth, despite its current debt. Furthermore, the debt levels are likely to have helped Mr. Wiese obtain a deal for New Look. Fashion retailing is a highly competitive market, but demand always appears to be growing. It is still relatively ‘new’ news, so we will have to wait to see what this means for the number of stores we see on the high streets and the number of jobs lost or created. The following articles consider this new New Look.
South African tycoon buys New Look fashion retailer BBC News (15/5/15)
South African tycoon enters UK retail fray with New Look purchase Financial Times, Andrea Felsted, Clare Barrett and Joseph Cotterill (15/5/15)
New Look snapped up by South African tycoon The Guardian, Sean Farrell (15/5/15)
New Look sold to South African billionaire for £780m The Telegraph, Elizabeth Anderson and Andrew Trotman (15/5/15)
Questions
- Why might a company become listed on the London stock exchange?
- How would volatile economic circumstances affect a company’s decision to become listed on the stock market?
- What do you think this purchase will mean for the number of New Look stores on British high streets? Do you think there will be job losses or jobs created by this purchase?
- How do you think the level of New Look’s debt affected Christo Wiese’s decision to purchase New Look?
- Which factors are likely to affect a firm’s decision to take-over or purchase another firm?
Many UK coal mines closed in the 1970s and 80s. Coal extraction was too expensive in the UK to compete with cheap imported coal and many consumers were switching away from coal to cleaner fuels. Today many shale oil producers in the USA are finding that extraction has become unprofitable with oil prices having fallen by some 50% since mid-2014 (see A crude indicator of the economy (Part 2) and The price of oil in 2015 and beyond). So is it a bad idea to invest in fossil fuel production? Could such assets become unusable – what is known as ‘stranded assets‘?
In a speech on 3 March 2015, Confronting the challenges of tomorrow’s world, delivered at an insurance conference, Paul Fisher, Deputy Governor of the Bank of England, warned that a switch to both renewable sources of energy and actions to save energy could hit investors in fossil fuel companies.
‘One live risk right now is of insurers investing in assets that could be left ‘stranded’ by policy changes which limit the use of fossil fuels. As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.
… As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.’
Much of the known reserves of fossil fuels could not be used if climate change targets are to be met. And investment in the search for new reserves would be of little value unless they were very cheap to extract. But will climate change targets be met? 
That is hard to predict and depends on international political agreements and implementation, combined with technological developments in fields such as clean-burn technologies, carbon capture and renewable energy. The scale of these developments is uncertain. As Paul Fisher said in his speech:
‘Tomorrow’s world inevitably brings change. Some changes can be forecast, or guessed by extrapolating from what we know today. But there are, inevitably, the unknown unknowns which will help shape the future. … As an ex-forecaster I can tell you confidently that the only thing we can be certain of is that there will be changes that no one will predict.’
The following articles look at the speech and at the financial risks of fossil fuel investment. The Guardian article also provides links to some useful resources.
Articles
Bank of England warns of huge financial risk from fossil fuel investments The Guardian, Damian Carrington (3/3/15)
PRA warns insurers on fossil fuel assets Insurance Asset Risk (3/3/15)
Energy trends changing investment dynamics UPI, Daniel J. Graeber (3/3/15)
Speech
Confronting the challenges of tomorrow’s world Bank of England, Paul Fisher (3/3/15)
Questions
- What factors are taken into account by investors in fossil fuel assets?
- Why might a power station become a ‘stranded asset’?
- How is game theory relevant in understanding the process of climate change negotiations and the outcomes of such negotiations?
- What social functions are filled by insurance?
- Why does climate change impact on insurers on both sides of their balance sheets?
- What is the Prudential Regulation Authority (PRA)? What is its purpose?
- Explain what is meant by ‘unknown unknowns’. How do they differ from ‘known unknowns’?
- How do the arguments in the article and the speech relate to the controversy about investing in fracking in the UK?
- Explain and comment on the statement by World Bank President, Jim Yong Kim, that sooner rather than later, financial regulators must address the systemic risk associated with carbon-intensive activities in their economies.
The New Year is a time for reflection and prediction. What will the New Year bring? What does the longer-term future hold? Here are two articles from The Guardian that look into the future.
The first, by Larry Elliott, considers a number of scenarios and policy options. Although not totally doom laden, the article is not exactly cheery in its predictions. Perhaps ‘life will go on’ and the global economy will muddle through. But perhaps a new recession is around the corner or, even worse, the world is at a tipping point when things are fundamentally changing. Unless policy-makers are careful, clever and co-ordinated, perhaps a new dark age may be looming. But who knows?
Which brings us to the second article, by Gaby Hinsliff. This argues that people are pretty hopeless at predicting. “History is littered with supposed dead certs that didn’t happen – Greece leaving the euro, the premature collapse of the coalition – and wholly unimagined events that came to pass.” And economists and financial experts are little better.
Two years ago, The Observer challenged a panel of City investors to pick a portfolio of stocks and rated their performance against that of Orlando, a ginger cat who selected his portfolio by tossing a toy mouse at a sheet of paper. Inevitably, the cat triumphed.
But is this fair? If capital markets are relatively efficient, stock prices today already reflect knowable information about the future, but clearly not unknowable information.
It’s the same with economies. When information is already to hand, such as a pre-announced tax change, then its effects, ceteris paribus, can be estimated – at least roughly.
But it’s the ‘ceteris paribus‘ assumption that’s the problem. Other things are not equal. The world is constantly changing and there are all sorts of unpredictable events that will influence the outcomes of economic policy and of economic decisions more generally. And central to the problem are people’s attitudes and confidence. Mood can swing quite dramatically, from irrational exuberance to deep pessimism. And such mood changes – often triggered by some exogenous factor, such as an international dispute, an election or unexpected economic news – can rapidly gather momentum and have significant effects.
Predicting the long-term future is both easier and more difficult: easier, in that short-term cyclical effects are less relevant; more difficult in that changes that have not yet happened, such as technological changes or changes in working practices, may themselves be key determinants of the future global economy.
One of the most salutary lessons is to look at predictions made in the past about the world today and at just how wrong they have proved to be. Perhaps we need to call on Orlando more frequently.
Why ‘life will go on’ thesis about global economy might not pass muster in 2015 The Guardian, Larry Elliott (28/12/14)
Who knows what the new year holds? Certainly none of us The Guardian, Gaby Hinsliff (26/12/14)
Questions
- Give some examples of factors that could have a major influence on the global economy, but which are unpredictable.
- Is economic forecasting still worthwhile? Explain.
- Look at some macroeconomic forecasts made in the past about the world today. You might want to look at forecasts of agencies such as the IMF, the OECD, the World Bank and the European Commission. You can find links in the Economics Network’s Economic Data freely available online. Explain why such forecasts have differed from the actual outcome.
- Why, if capital markets were perfect, might Orlando be just as good as a top investment manager at predicting the future course of share prices?
- In what ways is economic forecasting similar to and different from weather forecasting in its methods, its use of data and its reliability?
When Kraft took over Cadbury, it was seen as a large take-over, but its size pales in comparison to the potential takeover of AstraZeneca by Pfizer. However, having made two offers for the UK drugs firm, the US company has been rejected twice, saying the terms of the offer were ‘inadequate, substantially undervalue AstraZeneca and are not a basis on which to engage with Pfizer.’
Pfizer initially made an offer of £46.61 per share, valuing the company at £58.5bn, but this latest offer increased the share price to around £50 and raised the company value to £63bn. The rejection was relatively swift and the price still too low, though analysts are suggesting that a price closer to £53 may tempt shareholders. At the moment the negotiations between these two giants remain ‘friendly’, but with this second offer being rejected by the Board, there are now concerns that the takeover could become ‘hostile’ with Pfizer going directly to shareholders. Indeed one investor has said:
We were very keen that the two boards actually get around the table and disucss the bid … I’m never very keen when companies just dismiss things and don’t allow shareholders to take a decision on it … The key thing is that these businesses get talking to each other so they can hammer out a deal.
Following the second offer, shares in AstraZeneca rose by 10p, as the debate continued as to whether such a take-over would be good or bad for British jobs.
Cadbury was seen as a jewel in the crown of British industry and the same can be said of AstraZeneca, especially with the growing importance placed on the Science sector in the UK. While Pfizer has now given the British government further assurances about protection for Britain’s science base, there are still concerns about what this take-over would mean for British jobs. Pfizer has said that 20% of the company’s workforce in research and development would work in the UK and the planned R&D base in Cambridge would still go ahead. However, asset-stripping is a phrase that has been thrown around, based on Pfizer’s previous take-overs and, based on this history, many are suggesting that any assurances made by Pfizer will be pointless. In particular, Allan Black from the GMB union said:
Similar undertakings were given by US multinationals before which have proved to be worthless.
This was echoed by Lord Sainsbury who commented that any assurances made by Pfizer would be ‘frankly meaningless’. However, Vince Cable seems more confident about the consequences for British industry and said:
We’ve now received some assurances from the company that they will strengthen the British science base, they will protect British manufacturing … We need to look at that in detail, we need to look at the small print, we need to establish that it is binding, but as far as it goes, on the basis of what we’ve seen so far, it is welcome and encouraging.
We therefore seem to have a tale of two stories. On the one hand, the assurances of a US company that British jobs and its science base will be protected, but on the other hand, suggestions that we should take Pfizer’s assurances with a pinch of salt and that any take-over could be ‘devastating’. The truth of the matter will only be known if and when the take-over goes ahead and perhaps more importantly, whether it remains friendly and co-operative or does indeed go ‘hostile’. The following articles consider this medical take-over between giants.
AstraZeneca rejects Pfizer bid as US Pharma giant courts UK government The Guardian, Julia Kollewe and Sean Farrell (2/5/14)
AstraZeneca rejects new Pfizer offer BBC News (2/5/14)
AstraZeneca Pfizer: major shareholder urges talks The Telegraph, Denise Roland (2/5/14)
AstraZeneca rejects Pfizer’s raised bid of 63 billion pounds Reuters (2/5/14)
Pfizer-AstraZeneca offer: IoD warns intervention ‘disastrous’ for Britain. The Telegraph, Louise Armitstead (2/5/14)
Pfizer enters takeover discussions with AstraZeneca, sources say Wall Street Journal (2/5/14)
Exclusive: Pfizer insider warns that takeover of AstraZeneca could be ‘devastating’ Independent, Jim Armitage and Chris Green (2/5/14)
The Cadbury deal: how it changed takeovers BBC News, Ben Morris (2/5/14)
Pfizer set to make higher bid for AstraZeneca The Guardian, Julia Kollewe (1/5/14)
The UK’s response to Pfizer’s takeover bid is incoherent and misguided The Guardian, Larry Elliott (4/5/14)
Questions
- What type of take-over would this be classified as? Explain your answer.
- What would occur if the take-over became ‘hostile’?
- Using a demand and supply diagram, explain why share prices in AstraZeneca went up by 10p on the day the second offer was made.
- How would such a take-over affect British jobs?
- Explain how this proposed take-over could (a) boost British R&D in science and (b) harm British R&D in science.
- To what extent might there be concerns from the competition authorities were this take-over to go ahead? How might such a takeover affect Pfizer’s market share and hence its ability to charge a high price?
Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.
