The bank bailout should save British banks, but it’s not enough to kick-start the stock market. Or the economy
Just a month ago, Gordon Brown was unpopular with just about everyone. So imagine how pleased he must be this week. Not only did his bailout plans for the UK, announced last week, get a pretty favourable hearing from the media (MoneyWeek certainly approved of them) but this week he finds that the rest of Europe is following his example with a 15-nation bank bailout. Now it isn’t just the media who are impressed: the FTSE had risen over 8% by today’s close.
But don’t be fooled into thinking that everything’s now just fine. It isn’t.
Sure, the £37 billion package should be enough to recapitalise British banks, and it certainly should re-inject some much needed confidence into the sector. Indeed, the Libor rate on three-month dollar loans dropped seven basis points to 4.75% today. That might not sound like much, but it is nonetheless the biggest fall since 17 March, said the British Bankers Association – something that hints at the possibility of some loosening in the credit markets.
However while the bailouts might save the banks they won’t save the economy.
If “we are not already, we are likely to be in recession by Christmas”, says Andrew Wollaston, restructuring partner at Ernst & Young. House prices are still falling, unemployment is on the up, bankrupticies (both personal and corporate) are rising and there is no way the credit markets can possibly loosen up enough to turn things around from here.
“The worst is yet to come.”
And when it comes it isn’t going away in a hurry. Instead, says Citigroup, the average recession lasts two years and comes with an accompanying 25% fall in company earnings as a result. The current downturn (we can’t really call it an official recession yet) is just nine months old and earnings are only down 9%, suggesting that the slump in the real economy still has to feed itself into company balance sheets. 111 UK companies released profit warnings in the third quarter, the most since 2001. There are many more to come.
What makes things even worse is the fact that the bailouts will need to come with “very heavy tax increases or spending cuts” says Jonathan Loynes, chief European economist with Capital Economics.
So just as people are – quite rightly – reigning in their own spending, the economy is going to be hit with a double whammy of falling state spending and rising taxes. Right now, the stock market in the UK looks cheap on a p/e of 7.7 times but given the state of the economy it is hard to see how even that makes it a buy right now. Societe Generale’s Albert Edwards is pretty pessimistic.
He predicts an ‘ice-age’ contraction with p/es falling far further than they have already: “coupled with an ice age P/E contraction, we see global equity markets falling some 70% from their Oct 07 peak,” he said earlier this year.
“I expect the S&P to bottom around 500 (verses the 1,575 peak) and FTSE around 3,000.”
It’s hard to disagree.