“The ‘Primary Bear Market’ that started in the year 2000 and, in our view, never ended, has unquestionably resumed as a result of the reversal of global liquidity. We are now embroiled in potentially the worst credit contraction of any readers’ experience and the implications are alarming. Asset prices that specifically benefited from the preceding credit expansion will be the victims and will include most global equity markets, commercial and residential property and collectibles such as fine art and stamp collections. The duration is likely to be at least long enough to test the stock market lows set in March 2003 when the FTSE 100 was at 3278.”
This paragraph was first published on 4th December 2007 and has been repeated in each issue since.
In a world of 24-hour-a-day news, it is very easy to lose track of the key issues and the very important big picture. The providers of news can’t help themselves; they expand and comment on every swing of sentiment and every price move. At a time of economic deterioration the good news is often highlighted. After all, everybody wants the good times to come back.
The big picture is encapsulated in our repeated opening paragraph first published 4th December 2007. Since then most of the world’s stock markets have suffered very considerable weakness and are, in our view, now unqualified primary bear markets. If we are right, then they will go their full distance, which probably means before they are over, P/E ratios will be in single figures and the yield for, say, the UK All Share Index will be above 6% per annum. This means stock markets falling about another 50% from current levels.
Because of the above, 20% of the model portfolio is invested in the SocGen Global Bear Accelerator; this structured note is based upon the best performance [least negative] of three stock market indices; FTSE 100, S&P 500 and the DJ Euro Stoxx 50. We have published five-year weekly charts for each of them. We would draw your attention to the following key elements. The long term uptrend has clearly ended. The 30-week moving average, the dotted line, during the uptrend from 2003 supported the price. In 2007, the tops were formed. The trends are now clearly down, with the 30-week moving averages now suppressing the price.
When the price becomes extravagantly distanced below the 30-week moving average, an oversold condition is created, which needs to be worked off. No new decisive move down is likely until the 30-week moving average is again in close proximity to the price action. You will see that for each of the three charts, that is what has been going on these last few weeks and much of the oversold condition has been worked off. The next move down should take place relatively soon. Taking FTSE 100 as an example, we expect the next down leg to take it to about 4,500.
We have also published an up-to-date chart of the SocGen investment which has been in a decisive uptrend since October last year. We estimate further considerable gains. Our upside target is about 2,000, approximately 50% above current levels.
There is a very interesting contrast between what is happening in the United States and in the United Kingdom. This applies to the importance put upon the risk of defaulting on a mortgage compared to the risk of defaulting on consumer debt, such as credit cards. In the US, if you have a mortgage, you can return the keys to the lender and not be pursued for the losses. For this reason, and probably because the US has taken consumerism to its ultimate level, owners of property, particularly if in negative equity and suffering excessive mortgage payments above rental levels, choose to pay their credit card bills and default on their mortgage.
In the UK, banks and building societies can pursue mortgage defaulters into bankruptcy. For that reason, most UK borrowers make the mortgage payment their priority. But from here it all gets a bit murky; take a financially-pressed UK house-owner who paid his mortgage on time last month, but made only minimum payments on his credit cards. In effect he made a choice to pay his mortgage with money borrowed at excruciating rates of interest from the credit card company. Borrowers who did that when the credit expansion was still underway and house prices were seen as enjoying a never-ending spiral upwards, could, at periodic intervals, refinance and start again.
Now the fear is that people in this situation will hit a brick wall. There is a moment in the future for many, when the mortgage will become unpayable and the credit cards will be maxed out. Is it any surprise that pawnbrokers are booming? Nobody knows just how serious this problem will become.
Any optimism that the credit contraction is close to ending has no reasonable grounds. Banks’ balance sheets will be damaged further and their willingness to make new loans will continue to decline. Hard-pressed consumers will cut back; it has even been reported that this is now happening at the luxury end. Companies will fail; commercial property prices, as well as housing prices, will decline further; business activity will slow; and the primary bear market for equities will continue its painful journey south.
On 17th August, in the Sunday Telegraph, the headline was ‘Banks and Law firms slash graduate intake’, https://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/08/17/cngrads117.xml saying that property and legal firms had slashed their graduate intake by up to 80%. On Saturday 23rd August, in the Financial Times, the headline was ‘Unemployment insurers see City jobs as too risky’ https://www.ft.com/cms/s/0/0d83e1ca-705f-11dd-b514-0000779fd18c.html . The story said that City workers are being denied unemployment cover or pay premium increases of up to 200%. More recently, and perhaps the most ominous, on 25th August, in the Financial Times, the headline read ‘Inquiries on how to shed staff soar’ https://www.ft.com/cms/s/0/6c8bed96-723c-11dd-a44a-0000779fd18c.html . The employment outlook is getting worse by the day.
It has started so it must finish. The news bombarding us minute by minute, day by day, week by week, needs to be viewed with the force of the big picture in mind. Without a firm grip of the big picture you face being buffeted by sentiment swings. The force is the force, sentiment however wavers constantly.
On 17th March 2008 Lehman Brothers Holdings (see chart below) saw its share price fall to $20.25, a huge fall and very much to do with the Bear Stearns crisis. It was strongly rumoured at that time that if Bear Stearns went, Lehman Brothers would be next. Following the Bear Stearns rescue, on Tuesday 18th March, Lehman’s share price recovered to a high of $46.49. Of late, however the share price has again fallen to a new low of $12. This is a very good example of an inexorable bear market buffeted by changes in short term sentiment. It is now quite obvious that the initial post Bear Stearns rescue optimism was entirely misplaced.
• This article was written by John Robson & Andrew Selsby at Full Circle Asset Management, as published in the threesixty Newsletter.