Primary equity bear markets to which we are now condemned, commenced from levels where prices were much too high and won’t end until prices are much too low. Any premature expectation that the primary bear markets have ended is no more than a false dawn. De-leveraging, the unavoidable consequence of the credit contraction, is far from finished and will continue to create a never ending stream of forced sellers. Major stock markets should fall by as much as another 50%; in which case, FTSE will bottom out below 2,500. As unlikely as that may seem to some, it is no more than should be expected given the unprecedented conditions and the abiding lessons of history.
This paragraph was first published on 6th November 2008 in Issue Number 583 and is repeated each fortnight until eventually replaced.
On the 11th November last year I had the pleasure of giving the final address at our yearly conference, attended by over 250 people. For those who weren’t there it can be viewed by going to our website, it is particularly worthwhile because of the outstanding address by Woody Brock. The last thing I said in my address was that looking forward, the outlook for fullCircle’s client portfolios was truly outstanding; well, since that date they are up almost 9% and the outlook going forward, for 2009 remains outstanding.
No financial commentator can live today without repeatedly using the word “unprecedented”. Every new bit of data can be so defined as in almost every case it is the worst since records began or the worst since the Second World War; it is sometimes even the worst since the 1930s, just read the news items.
So far this primary bear market has behaved in an orderly and, dare we say, predictable fashion, if history is to be our guide, then it will not end until prices are much lower. According to Andrew Smithers, who makes a study of these matters, the S&P 500 is currently a few percent above fair value; is it likely that the bear market could end near fair value having started from being much too expensive? The answer is “no”; it is going to finish much lower; as we have said all along, it is capable of losing another 50% from here. Since the end of October, FTSE has been in a trading range between 3665 and 4655, it now looks pretty certain that, in the near future, it is going to test the low of that range, following which it ought to fall at least to the March 2003 low of 3392. The reason that we are so sure of this is because of a “new force” (more about this later) which, like a hurricane, has just the hit the shoreline and will manifest itself during 2009 on an unimaginable scale. It will bring markets to lows not previously considered possible and, more importantly, will crucify investor sentiment.
Two issues ago we identified the four key economic conditions that need to be tracked and we said that in each subsequent issue, until further notice, we would report upon them.
Housing market
On 3rd January the Financial Times reported that loan applications in November to buy a house fell to 27,000 from 31,000 in October. Analysts had forecast a figure of 32,000. Separately, the Halifax said the fourth quarter 2008 saw the fastest pace of price decline since records began in 1983, house prices were down 16.2% versus fourth quarter 2007.
Over this last twelve months, interest rates have fallen dramatically and mortgages have, as a consequence, become cheaper. However, as yet, the market has not benefited because the demands from lenders have become much more difficult to meet, they want bigger deposits and better financial information and anyway, it’s still cheaper to rent so the pressure remains to the downside. As the unemployment situation gets worse, as it will, it is premature to, as yet, see the housing market as an opportunity.
Unemployment
The recruitment companies Hays and Michael Page both say that the jobs market is still deteriorating rapidly. For the fourth quarter 2008, Hays’ recruitment revenue fell 22%. As businesses fight to survive, jobs are going to be continuously axed. Barclays Bank is cutting 2,100 jobs worldwide in its investment and money management businesses – slashing costs to cope with the fall-out from the credit crisis.
December jobless figures in the US shocked the market. For the whole year, they lost 2.6 million jobs – the worst year since 1945. Of that number, 1.9 million was for the last four months. If that level of job destruction continues, and it might, then that’s an annualised rate of 5.7 million. That kind of number is not in the market but it should be!
Consumer spending
We all know about this because it’s what we all do. The FT reported on 13th January that UK retailers had the worst Christmas on record with many of them slipping into bankruptcy.
In the US it has been reported that in December retail sales suffered the fastest fall on record. They were down 9.8% compared to a year ago and 2.7% month on month, twice what the analysts had predicted. As with unemployment, these dire numbers just weren’t in the market.
Consumers have embarked upon an era of austerity, from borrowing and spending to saving and paying down debt. They expect prices to fall further so they wait another month and then often change their minds altogether.
Corporate earnings
There are lots of examples of why corporate earnings are likely to disappoint and the market is certainly now reacting to those fears, however we don’t think for one moment that this “new force” that we alluded to earlier, is properly recognised and it is certainly not in the market. Of all the things that are going on, we think this is the big one. It is a simple, straight forward and comprehensible economic condition that will be the overwhelming force going forward.
Boardrooms everywhere are concerned with only one issue – survival. Companies have to do everything they can to stay in business. Many won’t survive but the aim of all will be to do whatever they have to to achieve that objective. They know that they are faced with a year of declining turnover, squeezed margins and tight credit; they also know there is too much supply and unless demand returns, some companies will perish or at least significantly downsize. Never has a situation so grave confronted the business world. They only have two options: to increase their turnover – impossible, or dramatically cut their costs. In practical terms, only the second option is available. So, for what is probably the first time – certainly since the 1930s, all companies will simultaneously and unilaterally make a decision to cut costs in 2009 by axing staff, capital expenditure and cutting or even cancelling dividends.
One company’s expenditure is another company’s revenue or another consumer’s wages. If one company gets into difficulty in normal times, it has to retrench but the market remains unfazed. Unilateral retrenchment is something quite new and a bit like at the start of the credit crisis, the scale of it is, as yet, unknowable except we know that it will be truly dramatic.
Corporate earnings are going to be adversely affected far, far more than anybody is at present calculating – and that’s not in the market.
Margaret Ewing of Deloitte put it succinctly: “Faced with an unprecedented speed of economic downturn in recent months, a further deterioration in credit conditions and exceptional uncertainties, CFOs have become significantly more risk averse and many are simply focuse on survival for their companies.
“Consequently, strengthening the balance sheet by whatever means available, including maximising cash flow and curbing expenditure, plus improving investor confidence, both debt and equity, are the priorities for CFOs in 2009.”
If we are right about all this, and we think, in broad terms, that we are, then the bear note investment will boom and we may look to increase exposure. The possibility is for a deterioration in stock market conditions far beyond almost anyone’s expectation.
This primary bear market will eventually lead to opportunities on the long side, particularly in Asia; part of our work is every day to monitor that potential opportunity. We are determined to correctly call the changing tone of markets no matter how long it takes and our diligent approach of doing the small things well all of the time will ensure our success in doing that.
• This article was written by John Robson & Andrew Selsby at Full Circle Asset Management , as published in the threesixty Newsletter.