That sinking feeling
September 5th, 2008
The last couple of weeks have seen confirmation of the downturn on both sides of the Atlantic. House prices continue to fall in the USA, and the UK. Latest figures show the UK market now down by 12.7% over the last year, with a big fall of 1.8% in August. UK Car sales fell by 18.6% in August, always a poor month for them anyway. Fears are growing of bad profits performance ahead in the US and the UK. Surveys of confidence and purchasing intentions are in negative territory.
Sometimes markets are even more difficult to understand than others. None of this should have been news to investors. Our forecasts of falling house prices, slowing activity, poor confidence levels and squeezed profits were not out of line with many other commentators. Arguably this should all have been in the price. Yet in the last few days there have been heavy falls as this poor background has emerged again as the talking point.
We said that we were looking for two conditions for a Stock market recovery. The first was fall in oil and other commodity prices, to relieve the inflationary pressure. That should in due course enable Central banks outside the US to cut interest rates, and reduce the need for rises by the Fed. As we predicted, this is now happening, with oil down substantially on its high.
The second was the creation of more liquidity in Western banking markets, as the banks recapitalise. Clearly, from recent price behaviour, this has not yet happened sufficiently. Substantial sums have been put into banks by existing and new shareholders, but banks are now being very cautious and regulators are reinforcing the caution long after the inflationary credit bubble has burst.
Both the ECB and the Bank of England kept their interest rates up this week. They are still fighting inflation more than recession, which does not help equity markets.
We have held off from investing in the main markets for our discretionary clients and glad we have. We are still looking for signs that there will be more credit and easier money to fuel a recovery. For the moment markets are mesmerised by the immediate prospect of worsening results and declining demand in many leading markets for goods and services.
It is a sure sign of a bear market, when the good news that everyone wanted, a fall in sky-high and inflationary commodity prices, drives the market lower when it finally arrives. This week the market has actually been falling on the lower oil price, because that will hit oil company profits. You could just as well argue that the falling oil price is good news for most of the market, lowering the inflation risk and cutting the costs of doing business. This week the market took the pessimistic view. Clearly liquidity is still tight.
Over in Euroland the economy too is sinking, shrinking in the second quarter GDP figures. Each main central Bank has now taken lower quality assets from banks as security for cash. Market participants are asking how much more of this can they do, and will they roll these facilities over? It reminds us there are now issues to work through in returning markets to normality, arising from the short term measures the authorities took when the crises were at their height and individual institutions were under threat.
It is still important to watch interest rates and banking liquidity. We are still more worried by prospects for the UK economy than for the US, in view of the large government deficit in the UK and the importance of house prices to the economy as a whole.
