“The Cassandras are wrong,” proclaims investment bank Lehman Brothers after a week when global markets groaned and the FTSE had its worst day for over three years (see also Why the UK market shakeout was long overdue). “Comparisons between today’s market conditions and those preceding the 1987 crash are probably wide of the mark.”
That much is true. It’s unnerving when markets from equities to commodities suddenly drop across the globe. Recent weakness in US dollar and bond markets is especially worrying, given the parallels to 1987. But this isn’t 1987 and the differences are more significant than the parallels. The biggest difference is in scale. Between early 1985 and the 1987 crash, the US dollar lost over a third of its value. This time, the US dollar has slumped around 10% since the end of 2005 – merely unwinding the gains it made last year. It’s effectively gone nowhere since the start of 2004.Bonds tell a similar story. In the nine months leading up to the crash, ten-year US Treasury prices fell so far that yields rose almost 50%. This time, yields have risen just 30% since last summer. While they’re looking more attractive, it’s nothing like 1987. Other bonds have come off even less: ten-year UK Gilt yields are only 16% higher than their January lows.
So if it’s not 1987, what is it? The press picked the US April consumer-inflation number (up 3.6% on the year) as the trigger for the sell-off. With the rampant rise of commodities recently, an inflation scare seemed a likely candidate. But compared to prior inflation data, April was nothing special. For example, January was up 4% year-on-year. Besides, US stocks were already falling 24 hours before the inflation news emerged.
It wasn’t inflation and higher commodity prices the markets took fright from, it was something new. Until now, most economists have been upbeat on global economic growth, even in the face of increasing interest rates, commodity and oil prices. But even the bulls are starting to admit that the US housing market looks sickly. The three-month average of new home sales has fallen 12% from last July’s peak and unsold inventories of new homes have reached all-time record highs.
Why does that matter? US housing is vital because the US consumer uses mortgage withdrawal to finance spending. This has got to such an extreme that last year US households withdrew more than they saved for the first time since the Great Depression. US consumers have been the main engine of global growth for years. If housing falls, consumption falls and usually knocks GDP growth for six. That’s why commodities fell first (40% of US copper use is for housing) and stocks followed.
So what happens now? Everything that was sold off has hit 200-day moving averages, which should provide decent support for a rally. The end of the housing story is not a done deal yet, so there’s time for the bulls to pile back into commodities for another rally. Most importantly, bonds haven’t yet fallen enough and stocks aren’t expensive enough for a rehash of 1987.
But two warning shots have been fired. One is to commodity bulls: ignore these markets’ deteriorating fundamentals to your peril. The other is to all risky-asset investors. As bond yields rise, it becomes more attractive to play safe and more dangerous to be in risky assets. Bull markets are like elastic bands and bond yields are the weights. Elastic only keeps stretching until it snaps.
James Ferguson is an economist with Pali International
What other experts think will happen to the markets
Jeremy Tigue, manager of the Foreign & Colonial Investment Trust. Current forecast for FTSE 100 year-end: 6,150 (forecast 5,850 in January) – “At the current level of the market, investors should buy.” Uncertainty remains about oil prices, interest rates and exchange rates, but company performance is strong.
Also, “there is still considerable takeover activity, which will support share prices”.
Mark Dampier, Hargreaves Lansdown. Current forecast for FTSE 100 year-end: 6,000 (forecast 6,000 in January) – “If you have been fortunate enough to make big profits over the past two or three years, there is nothing wrong in taking some profit. If your time horizon stretches to around ten years, then I would look at market falls as opportunities rather than something to get depressed about”.
Annabel Brodie-Smith, Association of Investment Trust Companies. Current forecast for FTSE 100 year-end: 6,200 (forecast 6,200 in January) – “Equity investments are for the long term, so with this in mind, investors should hold on and continue with regular investing.” Returns on money invested monthly have outperformed lump sums in the last five years so, “if you are cautious and want to sleep easily at night, choose regular investing”.
Patrick Evershed, manager of the New Star Select Opportunities Fund. Current forecast for FTSE 100 year-end: 5,000 (forecast 5,500 in January) – “Investors should be very selective and take some profits in shares which have risen very sharply in recent months and reinvest at least some of the proceeds in solid companies that have above-average yields [such as BT]”.
The market as a whole does not look too expensive, but
“I am… worried about the world economy, which I fear is likely to have an adverse effect on world markets.”
Source: The Daily Telegraph