Predictions go bottoms up

STOCK market analysts are reminding each other - and their clients - that historically markets do not fall for three years in a row, except during wartime or in a depression. Since there is no proper war and only a recession, not depression, this means that markets will rise this year. QED.

The history is not quite correct, there being a very small fall in London from 1960-1963. But the general argument, though neat and certainly convenient, is not really relevant, since profit expectations are so out of line with economics.

The latest consensus among analysts is that earnings will rise this year by 14% in the case of the US, by 7% in Britain and by 16% in the eurozone. This would carry more weight but for the fact that the same analysts' predictions for 2001 were scarcely less starry-eyed, whereas the outcome was a fall of 14% in the US, of 2% in Britain and a hefty 20% in the eurozone.

These predictions, known as 'bottom up', are a summation of all the predictions made for individual companies. They are thus open to the charge that the analysts are too ready to take seriously the optimism of chief executives and finance directors - and too often are employed by merchant banks who are doing business (or hoping to) with the firms in question.

With a record like that for 2001, it is hard to see why we should take the current US and eurozone predictions seriously . The most reliable economists' forecasts are that that the US economy will grow by 0.8% and the eurozone by 1%. Britain looks like growing by a little over 2%.

The blow that low growth can deliver to earnings can be seen from the fact that in the five years to 2001, the US average annual growth rate was a bulging 4%. Yet over that period, the rise in reported earnings was averaging 10%. Indeed, according to the US tax authorities, the rise was rather less. So achieving those predicted profit rises in the US this year, or indeed the eurozone, would be something of an economic miracle. Or perhaps a mirage.

The earnings so enthusiastically forecast are, after all, what companies choose to report within the wide limits allowed by the arts of accountancy. If they are achieved, they should not perhaps be taken too seriously.

In our own case, the earnings actually look achievable. It raises the prospect that London analysts may be more sensible than those in the US or across the Channel. It is a nice thought, anyway.

Cash is king
WE shall soon be seeing that always intriguing Equity-Gilts survey by Barclays Capital, normally and enthusiastically demonstrating the better returns from equities than gilts and - of course - especially better than cash. But the tough last two years will harm that pretty picture.

And here is an intriguing thought. Cash is normally a rotten performer. Yet over the last two years, it has comfortably outperformed both equities and gilts.

One should never be shy of holding cash, certainly not as shy as professional investment managers whose average cash holdings are usually under 5%.

Their problem is their reluctance to report to clients that they are only modestly invested. It makes them and their supposed expertise look redundant.

Off balance
EMAIL from investor to broker managing his portfolio: Worried about balance of portfolio - looks too weighted to equities.

Broker: Your portfolio has been automatically rebalanced. Gilts now outweigh equities.

Investor: Congratulations. Shall celebrate.

Broker: Cancel celebrations. Rebalancing results from large fall in value of equities. Also your portfolio now worth less than the £250,000 minimum we manage. Please arrange removal.