Nervously Awaiting The Bear
Has there been a clear indication of a major change in the stockmarkets in the past two weeks? Yes, the credit cycle is changing, the implications of which are overwhelming...
If our assessment that the credit cycle has changed is correct, the implications for the rapidly slowing UK economy are very serious. Indiscriminate lending to anybody with a pulse has, over recent years, been the norm. At no other time that we can recall, could one businessman borrow enough money to buy a company the size of Marks & Spencer outright, albeit Philip Green's bid failed. Nor at any time that we can remember, have credit card companies allowed large balances to remain with minimum payments of as little as £5 per month and new credit to be readily available to those same borrowers, without any investigation by the new credit provider into the applicant's credit-worthiness.
In the second quarter, economic growth in Britain slowed 0.4% to its weakest rate for twelve years. This should come as no surprise because, as we have been saying for many months, the inverted yield curve (long-term interest rates are lower than short-term interest rates) is an accurate forecaster of recession. We expect the UK's economic growth to turn negative. As Wolfgang Muenchau recently wrote in the Financial Times "What masquerades as an economic miracle in the UK, may in fact be nothing more than an old fashioned Keynesian boom".
Going forwards, the next big opportunity, might be an early investment in UK bear funds (these go up in value in direct proportion to the stock market going down in value). If we get a signal to open this new investment position, it will be at a level where we could operate a very close stop loss, which would mean if the market deceives us, we can be in and out without suffering much damage. The potential for such an investment is considerable because our view remains that when this market does turn down, it will retest the lows of March 2003.
In the US, Alan Greenspan, in what is expected to be his last ever testimony to Congress, said a number of quite extraordinary things, such as: "The regulatory system is not designed to influence or control asset bubbles, but rather ensure that bubbles, should they develop, do not lead to unsafe lending practices".
How can he make such a statement at a time when, according to the National Association of Realtors, 30% of house buyers purchase with a zero deposit? Not only that, but a large percentage have sub-standard incomes and elect, not just for interest-only loans, but loans charged at a notional rate of interest considerably less than the true rate, with the unpaid interest accruing to the debt. If these are not 'unsafe lending practices', what are? Furthermore, we would say to Chairman Greenspan that the final expansion of a bubble is invariably fuelled by "unsafe lending practices", not the other way round, and he must know that.
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As with the UK, not much has changed technically for the US market. The Dow Jones Industrial Average remains in its long-term trading range which commenced in January 2004 - the low was set in October 2004 at 9700, and the high was set in March 2005 at 11000. The end of this trading range is the very big signal that we patiently await.
If in the final analysis, it is a break to the downside, then the bear market, more likely than not, is well and truly back. If it finishes with a break to the upside, then stock markets, such as China, India and Japan would become very attractive.
We can't help but believe that we are close to something very big. We make such a statement, not bravely but nervously, well aware that the market likes to prove brave forecasters wrong. If, however, the credit cycle has turned, then everything else we expect should, in the fullness of time, come to be.
By R H Asset Management, in the Onassis newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit www.rhasset.co.uk
