Share prices plummet – but are they cheap enough to buy yet?

Stock markets around the world yesterday suffered their biggest falls since the September 11th terrorist attacks.

The FTSE 100 ended down 5.5%, or 323 points – which was its biggest ever single-day points fall – at 5,578, a level not seen since June 2006. And its European peers (the US markets were closed for a public holiday) were even worse off. The French CAC 40 and the German Dax Xetra both fell by 7%.

It was obvious, of course, why stock markets plunged on September 11th. But the cause of yesterday’s collapse was less obvious. No one piece of bad news could be blamed for the falls.

The truth is, yesterday’s seas of red could be put down to one thing. Investors across the world have finally woken up to reality. The Federal Reserve can’t save us from a global recession…

Why nothing can save the US economy from recession

Yesterday’s slump in global stock markets has been a long time coming. The clear signs that the US is heading for (or may already be in) a recession have been becoming harder and harder to ignore. In recent weeks, the only thing keeping most investors upbeat is the idea that the Federal Reserve would be able to slash interest rates and somehow jump start the whole party again.

But Ben Bernanke finally killed off that piece of dumb hope last Thursday, when he effectively called on the government for help. The fact that Mr Bernanke was suddenly looking to George Bush to get the electric paddles out and jump-start the US economy was enough to send shivers down the spine of even the most ardent stock market bull.

And when Mr Bush announced broad details of the stimulus package – tax cuts worth about 1% of US GDP, which any consumer in today’s environment would save rather than spend – it finally became clear to everyone that nothing was going to save the US from recession.

So now that markets have accepted what’s been obvious since the US housing collapse really got into its stride, will they start to recover? After all, many think that “this is the capitulation point, when investors ignore rationality, throw in the towel and assume the worst,” as Max King of Investec put it.

Well, no doubt we’ll see a bounce either today or in the next couple of days – probably as soon as the US market has a half-decent session. But even now, I don’t think that investors grasp the extent of the problems facing the global economy, and the West in particular.

The worst is yet to come

Banking losses are still nowhere near finished. The other thing that has investors rattled is the fear that America’s big bond insurers are about to collapse. The ‘monolines’ as they are also known, underwrote much of the dodgy debt that was issued by banks in recent years, enabling subprime loans to get AAA ratings.

Now the monolines are losing their credit ratings, and in fact might even be heading for bankruptcy. That would pretty much destroy the entire financial fantasyland on which the credit bubble was based. Banks will have to start writing down, not only the dodgy debt they took on, but also the insurance and hedges they took out against the dodgy debts going bad.

There’s a lot of this stuff still out there, and only so much foreign funding to go around. How long is it before a major US bank actually has to sell a controlling stake in itself to one of the sovereign wealth funds to avoid going bust? What kind of impact will that have on the way investors see the world?

And moving back to the markets – stocks may look cheap by historical standards. But how are companies going to grow earnings when consumers don’t have money to buy anything, and banks don’t have money to lend? How are firms going to grow or even maintain dividends when profits start falling?

Of course, that’s not to say that there won’t be opportunities out there. And our regular columnist James Ferguson has pointed out in the past that recessions don’t always need to be bad news for stock markets. He has been expecting the latest crash in values for some time, as markets come to terms with the idea of recession – but he believes that after the fall-out from the latest batch of jitters is done, there could be some real bargains. You can read why he believes that stocks can still thrive in a recession here: Avoid property – but I think shares are good value

Turning to the wider markets…

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Sharp falls spread to Asia

London’s FTSE 100 index tumbled 323 points to end the day at 5,578 yesterday, with mining stocks BHP Billiton and Rio Tinto leading the way with falls of over 10%. For a full market report, see: London market close

Across the Channel, the Paris CAC-40 closed down 347 points at 4,744, whilst financial stocks led the DAX-30 down 523 points to 6,790.

On Wall Street, markets were closed for a public holiday yesterday.

The heavy losses spread to Asia overnight where the Japanese Nikkei also suffered its worst session since 9/11, falling 752 points to end the day at 12,573, its first drop below 13,000 since . In Hong Kong, the Hang Seng slumped 2,061 points to end the day at 21,757.

Crude oil futures slump by 4%

Fears of an economic slowdown saw crude oil fall over 4% this morning to $86.79. And in London, Brent spot was at $86.16.

Spot gold fell to a three-week low of $857.65 this morning, and silver was at $15.49.

In the currency markets, the pound was trading at 1.9477 against the dollar and 1.3476 against the euro. And the dollar was at 0.6917 against the euro and 106.32 against the Japanese yen.

And in London this morning, the benchmark FTSE 100 extended yesterday’s losses this morning, plunging over 200 points to as low as 5,351 in early trade. Despite publishing record profits that met of exceeded analysts’ best efforts, publisher Pearson had only managed moderate gains so far today.

Our recommended articles for today…

Shipping index forecasts storms ahead
– The Baltic Dry Index of shipping rates has been sliding rapidly. It’s a good indicator of the global economy – so should we be worried, or is this a buying opportunity? asks Garry White. For more on how the shipping news just got a lot worse, see: Shipping index forecasts storms ahead

How to profit from rising food prices
– The price of an average basket of supermarket food has risen 12% in the past year. And with the Chinese embracing Western diets – and Western chains such as Pizza Hut and Starbucks, along with America’s grain-guzzling biofuels programme, prices look set to keep on rising. Merryn Somerset Webb looks at some of the best ways to invest here: How to profit from rising soft commodities prices