Stock markets fell for the third year running in 2002. Measured by the decline in the ratio of equity wealth to GDP, the current bear market is the deepest in history, says The Economist.

Yet not all investors have lost their shirts, points out the magaizine. “Remember Felicity Foresight? In December 1999 The Economist revealed how this little-known but brilliant investor had used an infallible investment strategy to become the world’s richest person. Her secret? Perfect foresight.”

When Ms Foresight was born in America in January 1900, her parents invested $1 on her behalf in a basket of shares. If it had been left there it would now be worth about $9,000. But Felicity reckoned she could do much better. Discovering at an early age that she could foresee the performance of financial markets perfectly, she would predict at the beginning of each year which asset around the world would bring the highest total dollar return (income plus capital gain) over the following 12 months. She would put all her wealth into that asset, and reinvest her income, before making a new forecast and shifting her money the following January.

By her 100th birthday Ms Foresight had turned her initial $1 into an amazing $1.3 quadrillion—i.e., 13 followed by 14 zeros—even after deducting dealing costs and taxes. Since then, despite the three-year bear market, she has enjoyed a post-tax average annual return of 29% thanks to some canny selections (Israeli, Russian and Czech shares in succession). Her nest-egg is now $2.7 quadrillion. Had she not had dealing costs and taxes to pay, she would, thanks to the effects of compounding, be worth an astonishing $27.5 quintillion (ignoring the fact that no market in the world is big enough to absorb such wealth).

In 2002, when S&P 500 shares yielded a total loss (including dividends) of 22%, Felicity enjoyed a 44% dollar return on her Czech shares. In theory, she could have made an even heftier profit in Pakistan, but she limits herself to stock markets covered in the back pages of The Economist. Gold, up 26% as investors sought a safe haven in an uncertain world, and London residential property (up by over 30% including an assumed net rental yield of 4%) would also have produced handsome rewards (see chart). Indeed, The Economist’s global house-price indices suggest that, once rental income is included, housing in most countries (apart from Germany and Japan) yielded double-digit returns last year. At the other extreme, Argentine shares saw the biggest drop. Among developed markets German shares fared worst, with a 33% dollar loss, even though the euro rose by 18% against the dollar.

During Ms Foresight’s 103 years, American shares have outperformed all other assets, returning 9.3% on average since 1900 compared with 4.8% on long-term Treasury bonds. Gold has yielded a dismal 2.8%, even less than the 4.1% return on cash (measured by the yield on American Treasury bills). Over the past ten years, however, the main equity markets have offered a lower return than either property or British government bonds (see chart). The best ten-year investment in our portfolio was London residential property with a total dollar return of 16%, well above the 9% earned on American stocks.

Despite the recent spurt in its price, gold’s long-term performance has been lacklustre, offering a ten-year average return of only 0.4%. But the worst investment of all has been Chinese equities. China may be the fastest growing big economy, with massive potential, yet Chinese shares have suffered an average annual loss of 16%. Emerging stockmarkets more broadly have proved a poor bet over the decade, even though in 14 of the past 15 years one of these markets has topped the global investment league. What goes up has then usually tumbled down.

This is where Henry Hindsight, an old flame of Felicity’s, has been badly caught out. He invests each January in the previous year’s best-performing asset. Henry is like a typical small investor who tends to follow fashion, buying East Asian shares or internet shares in the 1990s after they had already risen sharply—and usually just before they began to slide. Felicity’s best prediction was that marriage to Henry would never work.
Future imperfect

What is Felicity’s hot tip for 2003? Naturally, she is not saying. However, she has hinted that she is ignoring the advice of most American analysts, who reckon, on average, that the S&P 500 will gain 20% by the end of 2003. After all, share prices are still far from cheap. In previous bear markets equities have always undershot before staging a full recovery; this time valuations have remained well above their long-term average. The price/earnings (p/e) ratio for the S&P 500 using historic reported profits is currently around 30, compared with a 50-year average of 16 and lows of ten or less in previous bear markets. Even if forecast profits are used to estimate earnings, the p/e ratio still looks high.