The FTSE 100 had a great week last week – its best ever in fact. But investors shouldn’t get excited by this.
Why not? Well, the bounce may seem odd, given the economic backdrop, but in fact it’s not too surprising. If you look back, seven of the top-ten best percentage gains for the Dow Jones came during the Depression, according to Fullermoney.com. One came after the crash in 1987. And the other two have happened in recent weeks.
So, in other words, the vast majority of the biggest individual daily stock market leaps of all time fell within the grimmest economic period of the 20th century. It seems that the harder they fall, the higher they bounce. And it’s very possible that the current rally will continue, particularly as interest rates are bound to be cut sharply this week.
But the outlook for the economy remains bleak, as Friday proved. This isn’t a chance to get back into the market – this is one of those rallies you sell into…
Now is not the time to buy a general index tracker
The huge rebound in the FTSE 100 over the course of last week shows just how volatile stock markets get in times of uncertainty.
Some people use the rebounding argument as a reason why “time in the market is more important than timing the market.” The idea is that you should keep feeding your money in at all times, so you catch the bounces as well as the plunges. It’s one way to look at it. And certainly, trading is a very difficult thing to do – I doubt if even the most capable day-traders have managed to call all the ups and downs of recent months correctly.
But there’s another way to look at. Times of chronic volatility such as this are characteristic of turning points. The bulls are still battling the bears. There is still the sense in many investors that “markets have fallen so far, they must be cheap.” They still don’t fully grasp that the investment world has changed, and changed dramatically.
There may be a bear-market rally for now, but at some point in the next year, the market will almost certainly be lower than it is today. So if you’re a long-term investor, then I don’t think that now is the time to be buying a general index tracker.
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By all means, go hunting for cheap individual stocks – but be aware that the usual guides such as price/earnings ratio and dividend yield won’t be as much use to you as in the days of the bull market. P/e ratios aren’t much use when the ‘e’ is likely to fall sharply and unexpectedly. And dividend yields are only of any use if the company actually pays its dividend. You can read more about this in our recent cover story: Picking shares: how to tell gems from the dross. (If you’re not already a subscriber, subscribe to MoneyWeek magazine.)
A wide range of companies are feeling the squeeze
So why do I expect markets to keep falling? Simply because the economic outlook is continuing to deteriorate. As my colleague David Stevenson pointed out last week, cash is draining away from companies (see: Companies are leaking cash – that’s bad news for jobs). And now the recession is really beginning to bite.
It’s not just house builders and banks who are warning on profits – a much wider range of companies are feeling the squeeze.
On Friday, we saw telecoms giant BT (LON:BT.A) issue a profit warning, which sent its shares to below the 1984 flotation price of 130p a share. The problem is at its global services unit, which provides various IT and telecoms services to big companies, and has been a key driver of revenue growth in recent years. Profit margins at the unit – which now accounts for nearly half of BT’s total £20bn revenue – are set to remain at 7-8% compared to a 2011 target of 15%.
Earnings (before interest, tax, depreciation and amortisation) at the unit are set to come in at £120m, way below City expectations for £200m. It’s partly due to cost-cutting efforts being “slower than anticipated”, but also because of “the continued decline in high margin UK business.” With companies set to remain under severe pressure, there’s every chance they won’t have the money for big IT upgrades, regardless of how much it might save them in the long run.
Meanwhile, department store chain John Lewis, generally seen as a good indicator of the state of the high street, said that same-store sales had fallen by nearly 10% last week on the year before. That doesn’t bode at all well for results from Marks & Spencer (LON:MKS), due out later this week.
And cruise liner group Carnival (LON:CCL), which many had assumed would be immune to the downturn due to the power of the “grey” pound, dollar and euro, has had to scrap its dividends for the coming year. It said that bookings had slowed, and that by scrapping the payouts, it would be able to pay for new ships it has ordered for next year, without having to raise more money via bank loans or bond issues.
That’s a pretty grim tally for just one day. But you can expect more disappointments in the months ahead – and if there’s one thing the market hates, it’s to be disappointed.
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