This is a transcript of David Kuo's conversation with Alpesh Patel.
You can listen to download this podcast here.
David:
This is Money Talk, the weekly investment podcast from the Motley Fool. Now, regular listeners to Money Talk will know that we've had a number of value investors on the show, but we've neglected traders just that little bit too much. So today we're going to put things right, and just to show that there are other methods that people use to select shares, we have in the studio today the great, the wonderful, Alpesh Patel, who is chairman of Sterlingmarkets.com, and by the way, his list of books is enough to fill an entire shelf. Here's a taster of what he's written: Investor's Guide to Forecasting Share Prices, Investing Unplugged, Diary of an Internet Trader, Trading Online: A Step-by-step Guide to Cyber Profits, The Mind of a Trader. So welcome to Money Talk, Alphesh.
Alpesh:
Thank you. The only reason I've written so many, as my friends point out, is because I couldn't get it right to begin with.
David:
No, I don't think that's true at all. I tell you what, my sister bought me Trading Online: A Step-by-step Guide to Cyber Profits many many years ago – what a great book.
Alpesh:
I've got a story about that one, I was on Trevor McDonald Tonight, and that peaked at number two on Amazon UK's best-seller list, and it was behind some geezer who I'd never heard of called Harry Potter. I subsequently found out who he was, of course needless to say I didn't stay at number two as long as he stayed at number one, but it was a good old time to be at number two behind him, and ahead of Vikram Seth.
David:
OK, so can we start with the book that you call The Mind of a Trader? I think lots of people would like to understand what really makes a good trader, so what makes somebody good at trading, Alpesh?
Alpesh:
Well I was very fortunate, when I wrote that I got to meet ten of the world's leading traders from New York and London and Chicago, and the key common theme that came across in meeting all of them was discipline. They could have come up to me and said, oh it's just taking a big risk, or they could have said to me, it's something else, but every single one of them said it was the discipline to get out of a position, whether they were traders or investors, to get out when something didn't go according to their plan, whether that plan was exit at a 10% loss, or 25% loss, or exit if event A happens or event B happens, they had the discipline to follow the plan and exit, because they knew that the plan would generate profits over the long term – yes, they'll have some winning trades and some losing trades, but they knew overall the plan was skewed towards being profitable. So if you executed the plan, then like a simple, almost mindless activity, you should make profits at the end of it.
David:
So are you saying that they have an instinct for it? – or is it that they just have this discipline that they are able to follow?
Alpesh:
I wouldn't say instinct, it was that they prepared, whether you call it on paper, or in their minds, they had prepared that they will enter at say 100, they think over a period of time, for whatever reasons based on their analysis, whether it's technical analysis or fundamentals, they think the stock, or whatever security it is, would go to say 130, they think, however, if it drops to 80, they'll know they're wrong; they made sure that therefore their reward, 30, was greater than their risk, 20, something private investors often don't do, they're willing to ride something all the way down to ten from 100, just to try and make that extra 30 on the upside, because they want to maximise their wins, whereas the professionals wanted to maximise their profits.
So they had a few techniques, I wouldn't even call that instinct, that you could be taught, but with discipline, they ensured that, if it went down to 80, they got out – they didn't make excuses, they didn't do the things that all private investors tend to do, which is, oh well, if it was good at 100, it must be even better at 80, but maybe I was a bit harsh on closing it at 80 let me buy some more and average down, just so I don't have to take a loss – all these excuses they make, which financially don't make good sense.
David:
But why don't you though, Alpesh? I mean, isn't the whole argument that we've had lots of value investors on this podcast before, and the value investors tell us, if you enjoy drinking wine, you go to the supermarket, and you see that bottle of wine that you buy in week in, week out, and it costs you £10 a bottle. Now, this week you go in, and that bottle of wine is costing you £5 – now what do you do? Do you say, oh, there must be something wrong with that wine, so therefore I'm not going to buy it, I'm going to buy another bottle at £10, or do you say that, yep, because it's at £5, I like drinking this wine, I enjoy it, so therefore I'm going to buy two bottles now?
Alpesh:
No, what you do is, you ask that question, is there something wrong with this wine, you do ask that, because a stock is not a commodity in the way a wine or a box of Coca-Cola might be, where you know you're gonna get the same thing, regardless of price. Actually, with a stock, the price may well have fallen because there is something wrong with it, that there wasn't wrong with it when it was at £10, so we do need to look at why has the price fallen, it might not simply be that it's under-valued, it may be that it's under-valued, in which case, fine – you already own some of it, you own ample of it – that's why you want to ask the second question, which is, well what else is there available?
What is going to maximise my profitability, just because that one stock has fallen from £10 to £5, does that mean that's the only stock in the universe? – no. What usually happens is, you've got a little sort of stock demon sitting on your left shoulder saying, "You lost some money on that stock, so you've got to make it back on that stock" – the market doesn't know what you've made or lost money on, which security, today is a new day, it's a blank sheet of paper, you've therefore got to maximise your profits, and the way to maximise your profits is, with that blank sheet of paper, to look at the universe of bottles of wine or stocks, and say, which are going to give me the best returns?
It might be that, when you do do that analysis, that stock, which has gone down to £5, is the best one, not because you lost £5 on it, not because you're so focused on that one stock, not because you want to give yourself the psychological excuse and cushion that I will make my money back on this, but because you genuinely think, as if you had owned no stock at all, and were looking at just starting a new portfolio, you genuinely think, that is the one stock – chances are, it's not, and the reasons the chances are it's not is because it if was so well valued, so under-valued to begin with, how come it dropped in price to begin with? How come the rest of the market didn't have the genius insight that you alone outside of the billion odd investors, with their compounded PhDs and so on, had managed …
David:
Don't have a go at PhDs!
Alpesh:
No, no, no – we mustn't do that! But the point is, if the price has dropped even more, the decision you want to make is, do I hold on to it or not, not, do I fill my boots with even more, become less diversified, and put more money into a loss-making stock? Those things are different, and you probably don't want to go down that route, you just want to say, well, do I want to hold onto it or not?
David:
OK, so let's have a look at the internet in general – do you think people would be as good a trader today if it had not been for the internet?
Alpesh:
Well, the internet's given them some great advantages that actually a lot of private investors still don't make use of, first of all the costs, the transaction costs have come down immensely, and even if they're doing long-term trades, if they're using something like spread bets, then they're not even paying commissions. Yes, they've got some interest-related charges, but depending on what time period they're holding stocks, or it can be cheaper to do a CFD trade or a spread bet aligned for taxes and commissions than it can be just buying the stock outright, because the vast majority of people, for instance, don't want to turn up at AGMs, they're not that interested in annual reports and all the other benefits that they have.
David:
We tell them they should be though, I mean we tell them the difference between an investor and a trader. You are trying to promote this idea that people shouldn't really care about owning the stock in the first place.
Alpesh:
No, what I'm saying is, people should decide what kind of person they are. Let me put it this way, I, as you can see, I stand before you, six foot five, slim, Adonis-like figure, but if you said to me, I'm going to try and change you into a different kind of person, you should be this other kind of person, for instance, instead of being a trader, you should be an investor, you should do this – well there's many ways to skin a cat, and if that doesn't suit my personality, sooner or later I'm not going to stick to it, and so similarly, what I'm saying is, there are some people for whom, they're long-term investors, they want to not just own shares in a company, they want to know what the CEO has for breakfast, they want to know absolutely everything, and I assure you the board of directors hate those kind of shareholders, but so be it, that's not the shareholders' problem.
If the shareholder wants to go to the AGM, he wants everything to do with the rights of ownership, of being a minority shareholder, say in Marks & Spencers, having all the minority rights that a 0.001% ownership of Marks & Spencers gives you. However, for the vast majority of people who don't live in London, where so many of the companies' headquarters are located, and therefore AGMs occur, that's just not viable, and it doesn't make sense.
So they're actually paying for this right through having the share ownership and the commissions they're paying the stockbroker, but they're not using those rights, they're not reading the annual reports, they're not going to the meetings, and so on and so forth, and, one thing's for sure, they're never going to have the power to influence the board of directors, because they have a meaningless percentage of the corporate shareholding.
So for those people, they could just as easily save on the brokerage commissions, and be an owner through spread bets or CFDs, where they … I'm not talking about leveraging up, I'm saying you still take the same risk, it's not about, oh, you need less money to go into it, that's not the point – the point is simply, you're not paying the commission, that's all, and the reason you're not paying the commission is because you're not taking ownership of the shares, and you're not taking ownership of the shares, because what do you care about turning up to the AGM? – it doesn't really matter.
David:
The biscuits are generally quite good, aren't they?
Alpesh:
Good God! Well, I don't know – M&S' might be quite good, but can you imagine what they must be like at British Aerospace? – they're probably all oily and a bit greasy.
David:
So are you saying that Warren Buffett is a good example for people to follow?
Alpesh:
He's an ideal example for people to follow if they've got a few billion in the bank, he's my role model when I become the second richest man in the world behind him, because then I too will be a majority shareholder, I too will be able to pick up the phone, and say to the board of directors, you're not doing that, you're going to be doing this.
In fact, he doesn't even do that, because as you know, what he does is he says, "I want to find the right team" – a team, usually a family organisation, which is, he does two types of investments: either a family organisation which is so outstandingly committed to the product, they don't care that they're multi-millionaires, and we know these people exist, there's so many multi-millionaires out there who just love doing the business, they're not out in their Ferraris and their yacht, because they don't care about those things, and you'd think, what's wrong with them, why don't they? – but that's actually why they're rich, because they just love the product, whether it's making furniture in Arkansaw or Omaha, or wherever, these people exist because they're passionate about the product, and that's the kind of person he invests in, and that's fine and that's right, but you don't need to be the shareholder in the company in order to invest in those companies, you can just be relying on him picking those people, which in fact is what you do, you're not going to be able to pick those people, and take big shareholdings, and in fact even if you had a shareholding, you're still not going to be able to identify those people, because you don't have the same resources and individuals, so you don't need shareholdings there.
The other types of companies he invests in is where again the power of size and bulk gives him special negotiated deals. A classic example is Goldman Sachs, he could go in there, and of course that was a buy signal for the rest of us, just to buy into Goldman Sachs, but he actually got a sweeter deal than just buying the stock, as we all know – he got a deal whereby if the share price fell, he ended up being able to own crazy amounts of the company, fantastic, and if the price rose, well he made a killing because there were options, so it was all leveraged up as well.
Now, that was the sweetener, and he would say, well yeah, that's because I'm not buying a thousand pounds' worth, I was buying a couple of billion pounds' worth, fair enough, and that's a deal he can negotiate, but for the rest of us, it was a signal to get in. Now, you would have made just as much whether you bought the shares, or you did the CFDs or spread bets. Again I'm not saying do those alternative mechanisms just because the internet's made them more viable, I'm saying, it's just because it saves a bit of commission against the broker.
You're not using those products to leverage up, you're not using them to take greater risk – you're just taking the same amount of risk, so instead of putting £10,000 into a stock, you might just put a thousand pounds into a spread bet, because it's leveraged ten to one, so you just put a thousand pounds in – the same risk, it's just that you're avoiding the broker's commission.
David:
So how much time do people need to spend doing this then? You make it sound so simple.
Alpesh:
Well, you see the thing was, I was fortunate in that I'd taught myself to invest when I was studying at school, and then at university, and because I always had something else going on, I had to make the process as efficient as possible. The other reason I had to make it efficient is because I knew at weekends I'd far rather be playing with my nieces and nephews than sitting inside a small room reading a stack of annual reports, and you know there's these fantastic services which offer annual reports for free, and you get all excited, wow! – I get annual reports for free! – what more would a man or a woman want on a Sunday afternoon? Forget the kids, whatever! Never mind the grandkids, never mind the sunshine, never mind having fun, relaxing – no, no, no – I want to be reading British Aerospace's latest annual report, because I got it for free.
The problem with that, other than it stinks as a lifestyle, is you become sold, psychologically, on the stock – if you've spent that much time on a stock, don't tell me after spending ten hours researching British Aerospace, you're going to say, nah – I don't want to buy anything; you're not, you're going to think, oh, I've got to validate my time investment by making a small investment in the company – that's what you're going to do.
So that was another reason to get away from spending so much time, but also, when you look at the return on time invested when you're an investor, what you've got to work out is, how much am I making at the end of the year? Now let's say for argument's sake that you've got a hefty hefty portfolio, a hundred grand portfolio, and let's assume you're really good, you're nearly as good as Warren Buffett, and you make 20% in a year – that's £20,000 in a year?
David:
Correct.
Alpesh:
Assume you're not paying any tax, so that's a big assumption, let's just say it's in your SIPP, you're not paying any tax on it, so you're taking that £20K during that year. Imagine you have spent, well divide that by ten months, instead of twelve, just to keep the maths simple, so you've made two grand a month?
David:
£2,000 a month, yes.
Alpesh:
In a week, you've made £500. Let's say you have spent, during that week, you'd probably have spent maybe ten hours spread across a few days, or spread across a weekend, going through those annual reports, and so on – that's going to be about £50 an hour. £50 an hour, you might think – well, that's not too bad, better than what the guy gets at McDonald's – that's on a hundred grand portfolio with a near Warren Buffett return, and paying no tax. Remove those three factors, and most people aren't getting £50 an hour, they're getting about £10 to £5 an hour, they're almost getting minimum wage return on their portfolio investments.
So, how do they improve that return on time invested? – they've got to either increase the amount of money, stop paying tax (I don't recommend that), or get bigger returns. Well, given that more money and bigger returns are out of their hands really to a large extent, because, as we've seen with the markets, part of it is dependent on what happens in the market, what they've got to do is reduce their time to get the same output, they've got to become more productive, more efficient, treat it like a business, and the way to do that, and this is where the internet and actually software comes in, over the last ten years, is you use the software to datamine the fundamentals.
So what I'm saying is, follow the Buffett kind of way, or any other great investor, don't necessarily look at the trading side, the really short-term time-intensive side, but maybe say look, I want to find out the stocks which have got price earnings ratios below 15, which have got dividend yields of at least 2%, which have got price earnings growth ratios below one and above 0.2, I want to find the companies which have also got revenue growth year-on-year for the past two years at least, earnings growth year-on-year for the last two years – how are you going to do that?
You don't want to sit reading the FT on a weekend, or going through a load of annual reports – thankfully you don't need to, you've got software which datamines that, you put those inputs in, and it comes out with the names. There's software like Sharescope, at the end of the day it's going to cost you, what – about £150, £200 in a year, next to nothing, you datamine; Fool, Fool does the datamining for you, and comes up with the names, you're basically doing the datamining for the people, and if they followed those systematically, methodically, and said, right, that's how I'm going to do it, I'm going to stop listening to the bloke at the bar at the Dog & Duck, because everybody throws a bit of that in, because if I say to you, "Psst! – I heard a rumour, ah my God!" – any conversation starts off like that about a stock, and you know you're in trouble, but it sounds exciting.
Be disciplined, ignore all the excitement and all that rubbish, systematic discipline, have somebody do the datamining for you, whether it's your website, or whether it's a piece of software, that reduces your time investment. Now the problem is, most people, and research shows men in particular, they like to fiddle, they like to fiddle with their portfolios, they like to fiddle with themselves – whatever it is, they like to fiddle. That means, if you said to them, all you've got to do is press a button and datamine and get the names come out and buy those, and be systematic, they say, "Oh no no no no no! – I like to work hard for a living, I want to do more than that, I want to spend more time than just doing that", and they won't do it, but in actual fact, the criteria I've mentioned to you – they're all you need, it's all Warren Buffett needs: price earnings ratios for valuations, price earnings growth ratios for valuations.
For growth, for growth companies, layered on top of that, earnings growth, year-on-year revenue growth, year-on-year, and for income-generating companies, dividend yields. Overlap all of those five criteria, and you should have a good value growth income stock, one stock which has all three criteria.
Luckily you won't have that many names thrown up, but neither would you want them, because ideally you want a portfolio with maybe 12 to 14 stocks in it, not 100, like the funds, because if it's got a 100, I mean how bad can a stock picker be that he picks 100 stocks, because he can't even narrow it down to 12 decent ones? So that's the reason why you can use the technology actually to improve your return on time.
David:
So where do the charts come in then? – because you are a bit of a chartist as well?
Alpesh:
Yeah, absolutely.
David:
So you've found this stock, and you think, I've got to time my entry into the market – is that what you're saying?
Alpesh:
Well no, it depends – if I'm looking at the 12 month holdings, then I'm looking at value growth income based on the criteria that I've just mentioned, and I won't look to time it, I'll think, I'm going to hold this for 12 months. I may have been able to buy it a little bit cheaper, so be it, but let's just get on with it, because time is of the essence for me, and if I spend four hours looking at that stock, am I going to make that much of my return back on what else I could have been doing in those four hours? I could have been sleeping, for God's sake! – I put a high value on that. But in all seriousness, you should be able to do something else during that time. The thing is, we under-value time, we under-value it dramatically. Now, of course, there are …
David:
So are you saying that some people can over-trade? – just as easily as they over-analyse?
Alpesh:
At the slightest little thing, they can over-analyse, they can be just sitting there. Do you know which is the least productive OECD country in the world?
David:
No idea.
Alpesh:
It's Japan, you wouldn't think it'd be the Japanese, because they're so efficient – you'd think, can't be the Japanese, they're the least productive. Least productive means they have as output divided by the time taken to produce that output, they've got great output, they're the second largest economy in the world by GDP; the time they take to produce that output is excessive, in other words …
David:
But they achieve perfection though, don't they? You know when you buy a Japanese product that it is going to be right?
Alpesh:
Absolutely.
David:
The TV set, the car … everything.
Alpesh:
At their personal cost, so what happens is, imagine there's you and I, we're both picking a portfolio, and let's say you're going to get – what are you going to get in a year? – you're not going to get 100% return, over a long period, you might get that in a good year; but on average, chances are, you're going to, if you're any good, you're going to fluctuate between maybe 15% on average to 30% on average, because Warren Buffett's at about 24%, so chances are you're not going to be too far above him, and if you're good, you shouldn't be too far below him – that's your universe, so chances are you're going to be between 15 and 30, OK? Now, assume you're picking that portfolio, and you've come up with a return, and let's say you average, I don't know, 18% per annum.
Now let's say, I'm Japanese, and I have Japanese working … I'm talking about statistically, how productive the Japanese as a nation are … I will come up with the same portfolio, but I'll take twice as long over it, and because I'm a perfectionist, I may well get that extra 1%, 2%, so I'm outperforming you, I've got 20%, you've got 18, but I've just spent twice as long as you. Now tell me, who's the winner there? Is it me, because I can say, well I outperformed you, I'm brilliant, aren't I? – because I did a little bit better; or is it you, because you can say, well actually, I've just spent a heck of a lot of time earning money elsewhere, or with family or whatever, whatever.
So the point is, we're unproductive as individuals, because we don't use technology, we don't treat this like a business, we treat it like a pastime. If you treat it like a business, no businessman would ever let you pick stocks the way most private investors do, which is willy-nilly, a bit of rumour here, a bit of, oh there's an annual report sitting on the floor there, there's a newspaper rumour over there, there's a bit of Investors Chronicle over here, there's a bit of website over there – could you ever run a business like that? – of course not.
Now, if you're doing this as a hobby, for fun – fine, play around, do all those things, but don't think you're doing one thing when you're doing something else, don't think you're being a professional investor when actually you're being very amateurish, and it's going to cost you in terms of time and actually return – use the software, or use one site, and stick to that site, let them do the donkey work for you, the hard work.
David:
Even if it costs you money?
Alpesh:
Well, it depends how much, if it's only going to cost you a couple of hundred quid a year, far better to have invested that couple of hundred pounds a year to let somebody else do the work, as you would in a business, than try and do everything yourself and end up taking so much more of your time.
David:
OK, now you touched on Japan – I'd like to bring you just a little bit further to the west from Japan over to India, because I know you know an awful lot about India. I've had lots of people emailing me to say, how do I invest in India? So you're here, Alpesh – tell me, how do I invest in India?
Alpesh:
Absolutely, let's start right at the bottom – individual stocks, let's say you say to yourself, you know what? – those clever people at Tata have just bought Jaguar Land Rover, they're taking over the world, who'd have thought it, they own Tetley Tea – I want a bit of Tata.
So one of the best ways to do it is to buy the American depository receipts, the ADRs: these are US stocks of Indian companies, actually not just Indian, there's Chinese companies in there, there's actually British companies, there's European companies, all sorts, but they're listed on the New York stock exchange for all sorts of liquidity-related reasons we don't need to worry about, and you buy and sell them just the way you would Microsoft or any American stock.
So you use the same broker, same costs, same information requirements, because they're quoted on the New York Stock Exchange, so they've got to give the same disclosure, same regulatory cover as the American stocks, for better or for worse Americans, as we know, are not that great at regulating their companies, but anyway; so you can buy the ADRs, you've got Tata Motors for instance, ICICI Bank – you might think, you know what? – I've heard there's these big banks growing out there which didn't face the credit crunch, they must have some shrewd managers, I want a bit of that.
Or you might say, oil and gas, a billion people, growing at 8%? – I want a bit of reliance, because they're tapping into that kind of growth, 8% GDP – so that's where you start off with, you've got the ADRs.
The other way, moving slightly higher up, is you've got the exchange-traded funds. Now the ETFs are a bit like investments trusts, but they're more cost-effective, it's just the way they're structured, and the backers of the ETFs, the people who make the ETFs, the exchange-traded funds, are big banks like State Street or Barclays, so you've got good kosher, as it were, entities which are reliable, and what ETFs do is they track indices.
Now it could be an Indian index, or it could be a sub-index, they get quite detailed now, so you could have the Indian biotechnology ETF, for instance, and also they can be leveraged now, so you can have two times the Indian index, so it gives you all the returns you get on the Indian index, but multiplied by two, that's how it's constructed.
David:
Right, do you also get two times the loss?
Alpesh:
You get two times the loss unfortunately as well, and you've got inverse indices, so you can make a profit when, for instance, the NASDAQ's falling, which were great last year, they were fantastic during the credit crunch, because people make a killing, but the exchange-traded funds are the next route in, and the advantage, as I say, with those is they're prevalent, they have good issuers behind them, internal costs are low, because they don't actually have fund managers as such, because they're tracking indices, so they're not having to pay the hefty fees for useless City fat cats. So that's ETFs.
The next way in, which I don't particularly like, are just traditional fund managers.
David:
OK, why don't you like that?
Alpesh:
Well, some of them I used to lend money to when I was at university, and they were colleagues in my economics class, so that worries me already, but generally I don't think they're that bright.
Secondly, they have large internal costs, because of them having to market their products.
Thirdly, they make their money based on the assets under management, because they get 2% of the assets under management, not based on performance, so all they've got an incentive to do is to advertise well, not to perform well, because we know private investors tend to invest not in what's performed well, but in what's been advertised prevalently, M & G everywhere? – they must be good, Fidelity everywhere – they must be good.
The other thing investors occasionally do is yes, they do look at performance, historic performance, sadly, for them, statistically historic performance – forget the small print, historic performance is no guide to future performance, actually for fund manager performance, it is statistically unlikely to be a predictor of future performance.
In other words, the reason that a fund manager this year is a hot hand, in the top 10% or whatever, is more to do with chance than anything else. Consistency of performance of fund managers is very rare, in other words, just because somebody has come in the top 10% for the last two years doesn't mean they'll do it again, and so what do the funds do to cheat on that? – they say, upper quartile, ie that means you're in the top 25%.
I tell you what, if at school I was in the top 25%, my parents would be just so embarrassed – oh well done, you're in the top 25 out of 100. Given that it's your day job to be a fund manager, you're not in the top one or two for the last three years running.
David:
But they can't all be in the top one or two, can they?
Alpesh:
No, but the problem is, not even one of them can be in the top one or two for three years running – not one of them can be top dog three years running. That worries me – why? – because, if you throw enough rubbish into a pool, and then picking out random numbers, somebody's going to come out first, just statistically. That's what seems to be happening, and there's enough evidence to show that actually there isn't persistence of performance of fund managers, they just can't keep it up, as it were, there isn't a fund manager Viagra created at the moment sadly for them.
David:
Right, can I just ask you one final question, and that is for you to use the expertise that you have in looking at charts, and tell me, what do the charts say about the recovery?
Alpesh:
Well, as you know, I am a big fan of the charts, because it removes all the rubbish, in other words it removes opinion.
I rarely read the FT, the FT is a fantastic newspaper, the journalists are top notch, I used to write for them for five years, these are the best journalists you'll ever meet. The thing is, I don't want somebody else's opinion, what I want to do is try and remove anything where there's interpretation, and the closest I can get to that is either datamining on the fundamentals as I mentioned, just looking at raw numbers, not trying to predict which company's going to be the greatest next year, just looking at raw numbers – can they generate good numbers?
And the second thing is, does that then translate into share price movement, so I'm looking at trends, I'm looking at their valuation. So if I look at the FTSE 100, the problem we've got with the FTSE 100 is its current price earnings ratio is heavily, heavily skewed to over-valued, it's running at a multiple of about 77, which is excessive, it should actually be trading at around 15. However, if you look at the price earnings based on estimated earnings, as opposed to historic earnings, that is what we think the FTSE …
David:
What kind of profits are they going to be making next year, yeah?
Alpesh:
… next year, then it's trading at a multiple of about 15, in other words we're expecting next year's profits to be very good, not as bad as they've been over the last few years. The reason the FTSE won't collapse is because that probably will happen to profits, one reason is, when you thrown this much money into a system, you get the money illusion – you get inflation, you get the perception of rising earnings, these are nominal earnings we're talking about anyway, they're not inflation-adjusted earnings, and therefore earnings will rise, because there's more money in the system, there's more supply of money, therefore profitability looks as if it's rising, but of course inflation is, so in real terms it's not.
So one reason why the FTSE won't collapse is that, the other reason is, because we have the Dow, we're never that disconnected from the Dow. Now with the Dow, even on current earnings as well as estimated earnings, the Dow's trading on a multiple of about 16 on both, so that's a pretty fair valuation, in other words it could easily go down to 14, or go up to 18 as a multiple, it could easily go up basically roughly another 2,000 points, or drop another 2,000 points, it'd be within the bounds of reasonable volatility for the Dow.
So the Dow, I'd say, is well valued, I'm not going to say to you it's under-valued, fill your boots, I'm not going to say to you it's about to collapse; the one thing which would cause a fall in the FTSE would be a fall in the Dow, and the thing which would cause a fall in the Dow is if interest rates are raised in the US prematurely, which means any time before June, and the only thing which might trigger that is a spike in inflation.
I can't tell you whether inflation's going to spike, because for me to do that would mean I've got to look into the hearts and souls of about 250 million US consumers to see what kind of animal spirits, as Keynes put it, they've got – what things are going on, that's the unpredictability of the markets. What I can tell you is I would be positioned that, should inflation spike, and therefore interest rates rise before June of next year, I would be positioned to be more bearish on the market; if inflation doesn't rise, and interest rate indications are that interest rates are going to be held on hold, I'd be inclined to be neutral to mildly bullish, if I've got a full portfolio, I'm not going to bust a gut to try and expand that portfolio and put more money into the equity market; if I haven't got a full portfolio, I'd be looking to just incrementally put little bits in into under-valued companies, and that's how I see it at the moment.
David:
So you think the worst is over, yes?
Alpesh:
Only if interest rates aren't raised before June, if they are, the worst isn't over, we'll get another dip down. We won't break last March's lows, but we will fall, because the market will be very very jittery and nervous if rates start rising.
David:
I think we'll end there, because I think that's a good point to end.
Alpesh:
Perfect.
David:
OK Alpesh, now you may not know this, but I end each podcast with a quote which I manage to find from somewhere, and today's quote comes from Thomas Jefferson, who says, "Do not bite the bait of pleasure till you know there is no hook beneath it" – I think that more or less sort of sums up what we're actually sort of saying today, just be very careful when you're investing to make sure there is no hook underneath it before you actually bite it.
Alpesh:
Or get a medical health check on the person you're biting!
David:
OK, that's wonderful! Now this has been Money Talk, I have been David Kuo, and my guest has been Alpesh Patel. If you have a comment about today's show, you can do so on the Money Talk page, which you can find at www.fool.co.uk/podcast. If you have a suggestion about future shows, you can email me at moneytalk@fool.co.uk. So have a great week everyone.
