If you’d just looked at the stockmarkets on Wednesday this week you might have thought that conditions in the UK had somehow deteriorated: the FTSE 100 ended the day down over 5%. But actually, Wednesday was the day when things suddenly took a turn for the better. The co-ordinated interest-rate cut from the world’s central banks was pleasing. It won’t do much good in practical terms (the problem is more about the lack of credit than the price of credit); but still, it showed that the bankers are aware of the scale of the challenge facing them and that they are actually getting together to talk about it. That’s got to be at least a minor confidence booster for the global financial system.
Much better than this, however, was the massive banking system bail-out announced by the UK government. It has already been much criticised, but on this rare occasion we aren’t joining in. Instead, we’d say that the package looks like a pretty credible response to the crisis in that it addresses not just the problems of liquidity in the system but the problems of solvency, too. At some point, capital was going to have to be invested into the big banks by the government (who else at this point?), so surely better sooner than later. The preference share route also seems like the right one – it certainly worked to end the rather drawn-out Japanese banking crisis in 1999. And the idea of guaranteeing bank bond issues, while effectively meaning that they are all nationalised, will surely rip some of the fear out of the markets. Overall, the bail-out means that the odds of our entire banking system imploding are now much lower than they were on Tuesday. That’s the good news.
However, just because most of our high street banking names are now likely to survive in one form or another doesn’t mean that the UK isn’t going into a very, very nasty, and entirely unavoidable, recession. And it also shouldn’t con you into thinking that the bear market is likely to see a real bottom any time soon. There has been much talk about how cheap shares are on historical measures. The FTSE 100 is currently trading on a p/e (pe ratio) of 8.5 times. But this is only cheap if you think history began in 1985 – since then, say analysts at Mirabaud Securities, European markets have practically never traded under 12 times. However, if you think it started before that, 8.5 times isn’t necessarily cheap at all. Note that when the European markets bottomed in 1972 they did so on a p/e of a mere 5.6 times (having fallen 62.7%, says JP Morgan). So don’t fall for the much-mooted idea that to buy now would be cleverly contrarian. It might feel like it is for a few weeks, months even – there’s bound to be a big bear market rally at some point soon. But given the scale of economic trauma we’ll be seeing over the next few years, I can’t see it being a feeling that lasts very long.