It is an unusual state of affairs, but the fund-management community has come over all miserable. A monthly Merrill Lynch survey of more than 200 of them, taken in the second week of July, asked if they thought the global economy was getting stronger or weaker: 72% said they thought it was getting weaker and 11% went for stronger — the most pessimistic result for 10 years.
Still, if I were an equity-fund manager I’d be worried too. Just look at the state of the American economy. The housing market has already slowed substantially and there are ominous signs that suggest the end of the boom is going to bring trouble.
Stockmarket misery: why fund managers are worried
The S&P 500 housing index has fallen over 40% in the past year and there are more houses for sale in America than there have been since 1997. Add this to the rising price of energy and lower salaries (when inflation is taken into account), and America’s overburdened consumers look extremely vulnerable.
They have been amazingly resilient for the past five years but they can’t keep spending for much longer. Retail sales fell 0.1% in June. The 11% of fund managers who aren’t worried yet should also take note that the US yield curve is inverted. This means it costs more to borrow money in the short term than in the long term, which is not the way things usually work. This doesn’t happen very often but it is, as the Federal Reserve has pointed out, the only reliable indicator of a coming recession.
The curve has inverted eight times in the past 50 or so years and on six of those occasions a recession soon followed. This is bad news not only for the US but for all of us: if America moves into recession, the rest of the world is suddenly at risk of doing the same.
And if all that wasn’t enough to worry about, there is the new crisis in the Middle East to add to the mix.
No wonder investors have been selling up — the Americans and Japanese in particular have been pulling out of global equity markets.
Stockmarket misery: is this a buying opportunity?
The good news is that the classic way to interpret such misery is to suggest that it makes way for a rally. Why? Because with everyone out of the market and nervously holding high levels of cash (31% of the managers surveyed by Merrill Lynch said they were holding more cash than usual) it doesn’t take many to start buying again to push stocks right back up. Indeed the worse a crisis looks, and the higher everyone’s cash positions, the more likely there will be a turnround.
Ian Scott at Lehman Brothers points out that in the past, such periods of crisis and cash repatriation have preceded global equity returns of at least 15% over the following six and twelve months.
So now might not be a bad time to buy. This doesn’t mean, however, that you should buy indiscriminately or for much more than the short term. There are markets that could be in the middle of long-term bull runs — Japan and some of the emerging markets, for example — but the US and UK markets probably aren’t among them, especially if they are heading for recession.
Stock market misery: is a recession on the way?
Many believe that bull markets start at times when everything looks as though it is getting worse — like now. But this, according to Russell Napier, author of Anatomy of the Bear, is not the case. Napier has painstakingly worked his way through 100 years of market history to identify the four times when Wall Street hit big bottoms and kicked off new bull markets (1921, 1931, 1949, 1982).
The troughs all came not at the start of a recession but towards the end, when the news was no longer bad but looking up nicely and the papers were full of bullish comments.
Napier also notes that bear markets unfold much more slowly than most of us think, taking on average 14 years to move from trough to peak. They don’t end until the market in question is valued at a 70% discount to the cost of replacing all the assets it represents.
To Napier this suggests that, rather than ending in 2003, the bear market in America may have only just begun. Not only did valuations never hit the lows he would have liked, but shares had only been falling for three years.
There was also no recession and the economic news was getting worse not better (as it is still doing). History may suggest we are in line for a rally, but as far as Napier is concerned it also tells us that, in the US and UK at least, it won’t last long.’
First published in the Sunday Times 30/7/2006