Skyscrapers, the fear index, hemlines and burgers: Which financial indicators - both serious and silly - are worth following?

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Skyscrapers, the fear index, hemlines and burgers: Which financial indicators - both serious and silly - are worth following?

• Read why stock markets may be over-valued
• Why a company that builds a new HQ could be headed for trouble

By TANYA JEFFERIES
PUBLISHED: 07:12, 26 June 2014 | UPDATED: 10:15, 26 June 2014
Global markets might be riding high but the 'fear index' has got a lot of investors rattled that a big correction or even a crash is looming.
Otherwise known as the VIX or volatility index, its low readings are signalling calm - but that can mean danger of complacency and a tendency among investors towards risk-taking.
The VIX is in the spotlight right now, but it is one among a host of indicators - serious and not so serious - that keen market watchers keep tabs on to tell them what might be around the corner.

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Financial signals: What do burgers, miniskirts and fear levels tell you?

 

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They range from technical measures, like the Shiller ratio or margin debt level, to the wacky, like the hemline index and something known as the headquarters curse.
We've compiled a guide to some of the best-known below. But investors should treat such indicators with caution - some might well prove useful or informative, but none can be relied on when making important decisions about where to put your money.


Russ Mould, investment research director at AJ Bell, says: 'As markets move higher, investors need to watch the softer indicators which track market psychology as much as they do harder ones based on cold, hard numbers, to ensure they keep their discipline and always remember that the valuation paid for a stock is the ultimate arbiter of future returns.
'Good companies can be a bad investment if you overpay, just as less commonly bad companies can be a good one, if you buy in at a level where assets and cashflows are undervalued.'

 

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Market indicators: Fear, floats, takeovers and dinner party talk

The VIX

The VIX or fear index is a measure of the volatility of US stocks and is widely regarded as a global indicator of financial confidence.
It is measured on a scale of 1-100, and the higher the number the more volatile the market.
Low volatility is a sign of confidence among investors, but also of complacency and a tendency towards risk-taking. It is often followed by a switch to high volatility.

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Professor Robert Shiller: His ratio is a matter of 'quasi-religious debate' in the US right now between two different factions, the Shillerites and non-Shillerites

The VIX is currently becalmed at pre-crash lows of 10-11 - the kind of reading last seen in 2007 - prompting some to worry this signals that markets are about to descend into chaos again.
But it was also around these lows in 1994, and a few upsets notwithstanding the stock market still had a good run after that.
Valuations

Markets and companies can be analysed in many different ways but one of the most common measures is the Cyclically Adjusted Price Earnings Ratio or CAPE.

It broadly means price divided by the average of 10 years of earnings adjusted for inflation, and it's a popular, although not infallible, measure of whether markets or individual stocks are cheap or expensive on a historical basis.
CAPE is also often called the Shiller PE ratio after the influential American economist and Nobel Prize winner Professor Robert Shiller.
Russ Mould, investment research director at AJ Bell, says the US market valuation is a matter of 'quasi-religious debate' right now between two different factions, the Shillerites and non-Shillerites.
'A very respected US fund manager, John Hussman, is convinced US stocks are overvalued by around 50 per cent using Professor Robert Shiller's inflation/cycle adjusted 10-year trailing earnings, not least on the grounds corporate profit margins stand at an all-time high and thus at risk of reversion to the historical mean, at which point US stocks do not look cheap.
'In the end, competition, customer resistance to high prices or regulatory intervention tend to erode super-high corporate profits.'
Market breadth

If a market is up but only on the back of a minority of stocks - when despite overall gains, the majority of stocks didn't do particularly well - this is considered a signal to tread warily.
For instance, America's S&P 500 index set an new closing all-time high on 23 May, but it was remarked at the time that only around 20 of the benchmark's 500 constituent stocks posted new peaks, according to Mould.
On the same day, just 17 of the FTSE All-Share's 616 members hit a new high, he adds.
'Breadth has improved slightly since but still looks narrow.'

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Record breaker: The Burj Khalifa in Dubai, the world's current tallest skyscraper at 829.8 metres

Margin debt

Investors often borrow from brokers in order to fund stock purchases. When this practice becomes very prevalent - as it did before the Wall Street crash of 1929 - it is a sign people have become over-confident and the market might have peaked.
If margin debt levels are very high when a market plunges, many investors might have to sell stocks to repay their loans, making the situation even worse.
'Data from the New York Stock Exchange’s website shows margin debt now exceeds the levels seen at previous market peaks, to imply some speculative froth is creeping into the market,' says Mould.
Company floats

It's a bad sign when a lot of newcomers rack up losses.
Many firms have launched on the London Stock Exchange this year but although some got off to a decent start most have performed dismally in the aftermath of their debut.

Mergers and acquisitions

Frenetic takeover activity is another sign that a market might be getting toppy.
Mould notes recent research from Dealogic showing 2014 has already seen more hostile takeovers across the world than in any year since 2000.
'With debt cheap and returns on cash low this is understandable but the longer the cycle goes, the worse the quality of the deals and the higher the multiples paid.' says Mould.
Universal bullishness

'There are many ways to measure a stock market valuation. However, sentiment is a key factor,' says Gavin Haynes, managing director of Whitechurch Securities.
'It is often said that markets reach their peak when optimism can rise no further. Universal bullishness is a key sell signal.
'It is a sign of a market peak when your friends are telling you how much they have made in the stock market at dinner parties (or a sign to get more interesting friends) or when your taxi driver starts giving you share tips.'

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Mini or maxi? Hemline index suggests the shorter women's skirts get the better the economy and stock prices

 

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[h=2]Economic indicators: Skyscrapers, lorries and hemlines[/h][h=2]Official measures[/h]Trends in gross domestic product - the official measure of everything produced in an economy - unemployment and inflation are important gauges to watch.
'A growing economy is a prerequisite to good investment performance as well. The link between the two is not that close but generally speaking you would want an economy to be growing if you were investing in it,' says Tom Stevenson, investment director at Fidelity Personal Investing.
But he warns investors against focusing too much on GDP growth when assessing a country's investment potential, citing the example of China which has recorded economic growth rates of 7.5-10 per cent when more developed economies have lagged far behind that.
Stevenson says this made some people think China must be a great investment proposition, but there can be a wide margin between growth in an economy and the investment returns you can achieve.
'The principle reason for that is the main driver of investment returns is not growth. It's the price you pay,' he says.
'If you pay a high price for an investment you stack the odds against getting a good return. If you pay a low price you stack the odds in favour of getting a good return.
'People tend to overpay for high growth. As a result, the returns they get tend to disappoint and this has been the case in China.'

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Lorry use: FTSE All-Share Industrial Transportation index peaked six months ago, says Russ Mould of AJ Bell

[h=2]Proxies for wider economic activity[/h]Copper prices, South Korea's KOSPI stock market and the transport sector are all useful indicators that are worth following, according to Mould.
'Copper's use in many industrial areas make it a great benchmark for economic activity. The price has slumped amid fears of a Chinese economic slowdown,' he says.
'South Korea is a huge net exporter and a good barometer for the world economy.'
Meanwhile, Mould notes that the Dow Jones Transportation index is trading at fresh highs while the UK's FTSE All-Share Industrial Transportation index peaked six months ago.

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Seoul skyline: South Korea is considered a good barometer for the wider world economy because it is such a big exporter

[h=2]The 'R' word index[/h]The number of times 'recession' appears in newspaper articles can pinpoint when they happen, according to The Economist magazine, which tracks use of the word in the media.
'If not foolproof, it boasts a decent record,' says the magazine.
[h=2]Skyscraper index[/h]Skyscraper booms, especially plans to put up new 'tallest ever' buildings, are said to precede economic downturns.
No fewer than three recordbreaking buildings in New York - including the Empire State building - coincided with the Great Depression.
And building of the Burj Khalifa in Dubai, the world's current tallest skyscraper at 829.8 metres, arrived along with the Great Recession. Note the the massive fountain in front of it - see the picture above and the fountain indicator below.

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Lipstick index: Leonard Lauder, chairman of cosmetics firm Estee Lauder, reckons lipstick sales go up when times get hard

China and India are both busy throwing up skyscrapers at the moment. Saudi Arabia is trying to beat the Burj Khalifa's record with the one kilometre-high Kingdom Tower in Jeddah, planned for completion in 2018. But China has just announced that its Phoenix Towers in Wuhan will match that and do it even earlier in 2017.
The Shard at 306 metres is the tallest building in the UK.
[h=2]Fashion trends[/h]The hemline index is probably the most famous economic indicator based on fashion. Invented by economist George Taylor in the 1920s, it suggests the shorter women's hemlines get the better the economy and stock prices.
Leonard Lauder, chairman of cosmetics firm Estee Lauder, devised the lipstick index. He reckons lipstick sales go up when times get hard because women opt to buy make-up rather than more expensive fashion items like clothes, shoes and handbags.
It is also claimed that high heels get higher in an economic downturn, due to women's desire for escapist glamour, but shoes get flatter again during a recovery.
Men are apparently also susceptible to such trends, as tie sales go up when they become worried about losing their jobs. But it's claimed that ties get skinnier when austerity bites.
Meanwhile, the men's underwear index suggests that men cut back on such purchases during recessions, and it's an early indicator of recovery when sales start rising again.
[h=2]Company indicators: Fountains, helicopters, gold-embossed reports[/h][h=2]Fundamentals[/h]Price earnings or the PE ratio - price divided by earnings per share - is a popular method of trying to tell whether a company is undervalued or overvalued.
CAPE or the Shiller PE ratio, discussed above under market indicators, is a variation on the PE ratio that covers 10 years of earnings and is adjusted for inflation.
It's also worth checking what income you might get from a stock investment by finding out the dividend yield. Take a look at a firm's underlying assets using the price to book or P/B ratio as well.

Financial history in the making: Gordon 'no return to boom and bust' Brown opened Lehmans' new European headquarters in Canary Wharf, London

[h=2]Headquarters curse[/h]A company that builds lavish new headquarters is considered a very bad investment.
Lehman Brothers, the business which collapsed spectacularly in the worst days of the financial crisis of 2008, had opened new European headquarters in Canary Wharf four years earlier.
The official launch was attended by the then Chancellor, none other than Gordon 'no boom and bust' Brown. A plaque marked the spot - see the picture, right.
Fred Goodwin, disgraced former boss of Royal Bank of Scotland, spent £350million on a massive new office complex set in woodland on the outskirts of Edinburgh. Adornments included a fountain - see indicator below.
More recently, the beleaguered Co-op opened a new head office at One Angel Square in Manchester in late 2013 - see the picture, below. It wasn't a skyscraper but it was praised as the most environmentally-friendly building in the world.
[h=2]Fountains and helicopters[/h]'When you see in an annual report pictures of a fountain in front of the headquarters or a helicopter, that is always a really good sell signal,' says Tom Stevenson of Fidelity.
For those that enjoy playing guess the size of a boss's ego, he reckons there is quite a lot of crossover between affection for fountains and helicopters.
'A CEO who wants a big fountain in front of the headquarters is probably the same one who wants to fly their own helicopter.'
[h=2]Director departures and cost controls[/h]Gold-embossed annual reports and purpose-built opulent headquarters are both signs that a company has become complacent about controlling costs, according to Gavin Haynes of Whitechurch Securities.
'A high turnover of personnel, particularly directors is often a sign that an organisation is not a happy one,' he adds.
'If you telephone a company’s customer service and spend a long time waiting to get through, this is a worrying sign that a business is failing to service their customer base.'

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Ill omen? In 2013 the Co-op opened a new head office, which was praised as the most environmentally-friendly building in the world

[h=2]Currency indicators: Burgers[/h][h=2]Big Mac index[/h]The Economist tracks the cost of a McDonald's Big Mac in countries around the world as a way of gauging whether currencies are undervalued or overvalued.
'The average price of a Big Mac in America in January 2014 was $4.62; in China it was only $2.74 at market exchange rates. So the "raw" Big Mac index says that the yuan was undervalued by 41 per cent at that time,' says the magazine.
But it adds: 'Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible,'
[h=3]Why do investors love indicators? And which are worth watching?
[/h]The world is a complex place and people are simply trying to make sense of it, according to behavioural investing expert Greg Davies.
'We observe thousands of things going on around us and as humans what we really want is something that allows us to distill all this down to something our brains can grasp.

Greg Davies:' We have a complicated world and we turn it into stories'

'A lot of the reasons people like indicators and why they keep being used is that they simplify something complicated, something not intuitively comprehensible.
'You can think of this as an extension of what humans have done throughout history. We have a complicated world and we turn it into stories,' says Davies, who is head of behavioural and quantitative investment philosophy at Barclays.
He says over time good stories tend to survive and poor ones die out. But there are two categories of stories - those that contain a grain of truth, and those that just make a great story.
'The really good ones have both,' notes Davies. 'But there are some good indicators that don't grab people's imagination enough so they die out.'
Davies says an indicator like the hemline index expresses an underlying truth, which is that economic conditions have an influence on culture.
So it can perhaps say something about the current state of the economy, even though Davies hastens to add he knows no serious economist who thinks the hemline index can predict where the economy is going.
Davies has his doubts about the VIX or 'fear index' though.

'It's about the degree to which people think they need to protect themselves. It will be low when expectations of negative events are dampened, or that negative events will cause a lot of harm are dampened.

Burgernomics: Davies likes the Big Mac index because it informs people in an engaging way about relative exchange rates and the purchasing power of different currencies

'People pay a lot more attention to volatility than they should. Volatility is a lot less important than people tend to think. It's mostly an indicator of your emotional state rather than any financial reality.'
Davies draws an important distinction between volatility and risk.
'Risk is the chance of not having a good outcome when you need the money. Volatility is how turbulent is your journey in the short term.
'Investors spend a lot of time protecting themselves against emotional distress that is irrelevant to their financial situation.'
When it comes to indicators involving grand projects, like new headquarters or tallest-ever skyscrapers, Davies does think these can tell us something useful about the hubris of those involved.
A country or company builds these things because they think they are at the top - and this is a kind of pride that is in itself a self-fulfilling prophecy of a fall, suggests Davies.
He adds that merger and acquisition activity, where bosses are keen to expand their business empires, can sometimes be a good decision but is often driven by overconfidence and hubris too.
Meanwhile, he likes the Big Mac index because it informs people in an engaging way about relative exchange rates and the purchasing power of different currencies.
Davies stresses that his point about indicators being 'just stories' is not meant to imply this is something negative.
'People need stories and stories are very useful.'