Desperate to find a reason to buy stocks? You aren’t alone. Everyone wants to be the one to pick the bottom of the market and to make the fortunes that tend to come with doing so.
This week’s BusinessWeek devotes pages to looking at the best stocks to buy at the moment. This month’s Smart Money (a magazine produced by the Wall Street Journal) has as its main headline the pronouncement that “now’s the time to jump into cheap stocks”. Nearly all the UK’s main newspapers have also run columns this week telling us that with all the “blood on the streets” we should be beginning to buy.
And most prominently of all, Anthony Bolton, the man with the most successful investment record of any UK fund manager, had announced that he sees value all over the place and that he has started to reinvest his own money.
The argument for buying is pretty straightforward. Not only is this the moment of maximum pessimism, say the bulls, but markets are extremely cheap on historical measures.
But I think both of these justifications are questionable. Given the number of people urging us to buy, this quite clearly is not a moment of maximum pessimism. And as for valuations being at historical lows, well, that depends what you mean by history.
Right now the FTSE 100 trades on a price/earnings (p/e) ratio of 9.4 times, the Dow Jones on 13 times, and the DJ Euro Stoxx 50 on 9.2 times. These valuations look really low compared with where they have been over the last 20 years or so. But look back a little further, say analysts at Mirabaud Securities, and they aren’t particularly low at all.
Pre-1985, the market “frequently” traded below 8 times “in periods of economic difficulty”, and in the UK between 1962 and 1972 “trend p/es were rarely above 9 times”.
Much the same apparently goes for the US. Sure, p/es under 11 or so have been unusual for the last 20 years but “turn the market clock back before 1985” and p/es below 11 times look perfectly normal. Indeed, for much of the 1970s, the S&P 500 traded not far above seven times (having fallen 48% over nearly two years).
Right now, we think of any p/e below 10 times for any market as being some kind of a historical floor. But it isn’t so. Just because many of us can’t remember the markets of the 1960s and 1970s, doesn’t mean they aren’t as repeatable as the markets of the 1990s.
A final point the bulls will insist on making is that the market is a “discounting machine”. It shouldn’t reflect just what is happening now but what is likely to happen in the future. Given that, they say, it should now be looking beyond recession to the green shoots of recovery that will appear some time next year.
But that assumes we are going into a shallow recession (something the market is accounting for already). I don’t think we are. Instead, I think we’re going into a really nasty and quite long-term one.
The vicious circle kicked off by the end of the credit bubble is well underway – and at this point probably unstoppable. House prices are falling fast and, given the dearth of mortgage finance and of confidence across the market, they are certain to keep doing so both here, in Europe and in the US.
Note that the number of mortgage products on the market fell by 11% last Monday and that most lenders spent the rest of the week adjusting their remaining rates upwards. On Thursday, Nationwide raised all its fixed rates by 0.2%, for example. Falling house prices mean rising defaults – something that won’t exactly do anything to ease the problems at the big banks nor encourage or enable them to reverse their newly stingy lending policies to individuals or to businesses.
Several banking specialists have told me over the last few weeks that they expect bank lending over the next 12 months to be no more than half that of the last 12 months – however many bail-outs we end up with. Judging by the mortgage numbers in August – loans were down 95% – that is a perfectly reasonable forecast. Falling house prices also mean falling consumption. Numbers from Experian already show shopper numbers at out-of-town warehouses in the UK down 8% while US car sales fell 27% in September. This, combined with a shortage of credit, can only mean fast falling profits and rising unemployment. If you aren’t selling much and the bank has just withdrawn the overdraft you usually use as working capital, what do you do? You fire people. And so the cycle goes on.
My point is that the market, far from being too pessimistic about the future, is probably being far too optimistic about the future. It would be better to look at the shocking numbers on everything from manufacturing production to housing to consumption coming out all over the world and discount proper disaster than to even begin to dream of a recovery. That’s just too far off.
Given the number of people thinking good thoughts about markets, I wouldn’t be remotely surprised to see something of a bounce between now and Christmas. But don’t think for a second that means the bear is banished. Instead it could just be getting going.
• This article first appeared in the Financial Times