Is the capitulation coming in markets?
Posted on 01 March 2009 with no comments from readers
Reading the Sunday papers is a depressing business with a morbid focus on economic recession or depression, and this weekend rather an obsession with death in the UK, from the tiny Ivan Cameron to the marriage of a terminally ill minor celebrity.
Is this the darkest hour? The dark before the dawn? It certainly has the feeling of capitulation that marks a bottoming in the affairs of mankind and stock markets.
Capitulation
So what happens when the world throws in the towel? How low will markets go? Global trade is perhaps the forward indicator and the falls in trade have been astonishing, led by the 46 per cent collapse in Japanese exports in January.
After this sort of bad news stock markets ought to take a tumble in a climatic sell off and house owners finally accept much lower prices.
The good news is that once you hit the bottom then the only way is up. Of course it will never feel like that at the bottom. It will feel as though the world has come to an end.
Terminally challenged
For some people that will be true: the highly borrowed who lived a fantasy life at their creditors’ expense; and unfortunately those creditors are also deeply in trouble and many banks will not escape nationalization.
There is also not necessarily an immediate bounce off the bottom. It needs a catalyst: a new regime of low interest rates; a new prime minister or a major war. You need something to stimulate demand.
However, for the investor bottoms are the time to get interested. These are the times when the winning deals of the next boom are made, and small businesses started that later turn into bigger players.
On the other hand, if what we are seeing is really a once in a hundred years’ economic event then you also have to turn your mind to the consequences of the so-called solutions now being put into place.
Government role
The extension of government into finance, for example, puts the dead-hand of the state into banking and is going to slow any recovery down. Then again the pumping of money into the economy is going to be highly inflationary and hit people on fixed incomes.
Investors are going to be hard pressed to earn above inflationary returns in this kind of economic environment, and getting a job with the government might be the best option going. The financial sector has a dismal future indeed.
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no Comments posted by readers:
It seems to me, at this time some bottom fishing might be profitable. One needs to de the homework, instead of just waiting.
Yes Peter. It is obvious that gold and silver are becoming the world.s reserve currencies once again which explains why central banks and hedge funds hope to scare off investors with less than 100K net. No need to demean the memory of lil deceased Ivan Cameron and his father’s love for him by linking them to the tawdry world of money. Some things are priceless. My investment in gold and silver could never compensate for a loss of a child. Perspective and respect Peter. Those things are priceless beyond my many thousands of ounces in gold and silver. And perhaps the reason that parents seek a safe haven for their children’s future, not their own.Take your own advice and realise that we live in extraordinary times that will change the world’s priorities in more ways than mere money. Cheers
Well, we are reminded of what is truly of value by the loss of mere money – and more of that stuff has indeed vanished since this article appeared. But rather like life money does not matter so long as you still have it.
With the Dow Jones Industrial Average firmly under 7,000, the US stock market is now well below its early-1995 level, adjusting for changes in nominal GDP.
By Martin Hutchinson, breakingviews.com
Last Updated: 1:23PM GMT 03 Mar 2009
That suggests it is cheap, assuming growth prospects are as good as they were back then. But there is a risk to such a an analysis: too much fiscal and budgetary stimulus could bring on growth-stultifying inflation.
Fast back to December 5, 1996. The Standard and Poor’s 500 Index closed at 744.38. That evening, Fed Chairman Alan Greenspan decried the market’s “irrational exuberance”. On the S&P’s close of 700.82 on Monday, the market is clearly exuberant no more.
It is not, however, exceptionally low. Greenspan announced a new easier monetary policy to Congress later in early 1995. That day, the Dow Jones average, which had been generally rising since 1990, first reached 4,000. Adjusting for the 95pc increase in nominal GDP since that time would give an equivalent Dow level today of around 7,800. That suggests that current levels are only somewhat below their long term trend, and that the 1996-2007 period represented a lengthy bubble.
As for the S&P 500, Standard and Poor’s currently projects 2009 earnings on the index of $48.10. Over the 20-year period to 2008, it traded at an average of 19.4 times earnings. That would imply a current value of 933.14. That 20-year period however includes the 12-year bubble. Taking a longer-term average of around 15 times earnings gives a valuation of 721.5 – again, just slightly above the current level.
So, based on 1995 stock prices and long-term earnings considerations the market is just below a middling valuation. However that assumes US growth and earnings prospects are as good today as they were in 1995, or over the long-term average.
That’s where doubts creep in. If the exceptional monetary stimulus since September produces inflation, which needs to be squeezed out, or the unprecedentedly large budget deficits in fiscal years 2009 and 2010 “crowd out” private investment, then growth and earnings prospects for the next few years would be below average.
In that event, the market as it stands today would be overvalued. Bailouts and stimulus can thus produce long-term uncertainty as well as short-term uplift.