When and where will global capital markets bottom?

Posted on 23 October 2008 with no comments from readers

Global stock markets have been falling relentlessly for several weeks. There may not have been a single day with a crash to beat 1987 but cumulatively the effect is far worse, and the idea of a quick snap back like in 87 looks unlikely. This looks more like 1929 (see opposite) though as this article explains inflation is going to change that to something similar to the 1970s.

First the sellers have to be fully flushed out – once everybody who might sell has done so then the downward pressure on prices will end. At the moment there seems no sign of it. Huge volumes of shares are moving through the markets.

The London Stock Exchange has had 12 record days of trading in the past four weeks. This is de-leveraging by over-borrowed funds and everybody else deciding to get out of stocks as well.

How low?

How much longer can it go on? Uto Baader, founder of Germany’s biggest stock broker, says only a 15-20 per cent further decline can be contemplated until we hit rock bottom. That is still rather a lot from today’s much lower base.

But at some point the inflationary uplift from the multi-trillion dollar bailout of the global banking sector is going to enter the stock market and inflate stock prices. Whether that will be above or below the increasing inflation in general prices remains to be seen.

However, it could come as a nasty shock to those liquidating stocks and going into bonds. Warren Buffett has just said that he is doing the reverse, and avoiding a bond market collapse might be his main motivation for doing so.

Cash is king

On the other hand, so pitiful has been the five and even now 10-year annualized return on the S&P that you would actually have got a better return on a bank account. Stocks, as we should remember, have been in a bear market for many years, and this looks like getting worse. It certainly is not getting any better at the moment.

The bond market crash would also be the end of the US dollar rally – so it would make sense to abandon the dollar for other currencies in the near future. Almost anything would be a better currency to hold when the T-bond market blows but a diversified spread of currencies including gold and silver would be advisable.

But in the synchronized capital and commodity market sell offs that we are seeing today the question still remains: which market will rally first?

I think inflationary money supply injections will appear in the commodities complex first, producing a rally in oil and industrial commodities as well as gold and silver – although retail investment demand should lead to the earliest rally being in precious metals.

Commodities and inflation

Stock markets and equities associated with the commodities complex will also therefore rally, and lead a recovery in stock markets, albeit modest and from very low levels. Thereafter inflation will be the main factor driving stocks higher.

Given the Middle East bourses obvious correlation with the oil price I would expect these markets to rally more strongly than elsewhere, and also Russia and Brazil. But conversely China and India will suffer from rising commodity prices and their bourses will remain depressed.

Global real estate is a long way down this chain of cycles and would be among the last asset classes to recover, although in the US a bottom can not be very far away. The GCC real estate markets will be last into recession and the first to come out of it.

Chinese recession

However, stock markets in the major Western markets could be in for a very long bear phase as a severe recession will depress earnings for a considerable period and result in bankruptcies, consolidations and write-offs. Asia looks a better bet for a swifter recovery and arguably Chinese stocks at 70 per cent down will be the most immediate buy, although the market has yet to factor in a recession in China and India.

I consider this an obvious eventuality. Emerging market cycles are typically more severe than developed markets, and yet for some unknown reason everybody thinks China and India can carry on growing while the rest of the world is in recession. This is highly unlikely and will come as a big shock. Perhaps when this is factored into global stock markets we really will have a new bottom.

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