This is not the time to buy stocks
FREE email from MoneyWeek
Discover the latest profit opportunities and understand what’s really going on in the investment world with our punchy daily email. CLICK HERE
This genius investor does dizzying levels of research to uncover...Half Price Shares!
What’s going to make everything go horribly wrong? In a word: property. Stockmarkets have been on a tear recently, in an odd Alice-through-the-looking-glass world where all bad news is somehow good. But there are deep systemic problems ahead. And that means the good times can’t last.
The biggest problem is probably the real-estate slowdown. Many made the mistake over the summer of assuming that the US subprime mortgage debacle had arisen in isolation, and was therefore a localised event with no meaningful impact outside the US. The ensuing global credit crunch and interbank lending crises have now put paid to that assumption and redirected attention to the world’s other property bubbles.
In September The Economist published a list of those countries whose property markets have seen prices rise even more than they have in North America over the last ten years. They include Denmark (where property prices are up by 121%); Belgium (131%); Sweden (138%); France (139%); Australia (149%); Spain (189%); Britain (211%) and Ireland (251%). There are offsetting factors all round: lower real interest rates, higher real incomes, immigration and so on, but the headline price rises remain eye-catching. The fall in property prices in the US has still been relatively modest, but if even this can cause the trauma of the last few months – and in so many markets and products where US mortgages play a significant part – it doesn’t take too much imagination to foresee a global outcome where multiple housing markets contract simultaneously.
And it is Britain, of course, that is now in the frame for some form of housing-related slowdown, or worse. Martin Wolf points out in the Financial Times that while the US price-to-rent ratio for housing was 36% above its long-run average in 2006, the UK’s price-to-rent ratio was 66% higher. Last week’s Halifax survey showed that UK house prices fell in September, albeit by a modest 0.6%. While it is still too early to say just how negative the impact of the credit crunch and the run on Northern Rock will prove (particularly for the lending, construction and retailing sectors), suffice to say that investor sentiment is fragile.
The City is busily dispatching staff involved in credit and mortgage products, and commercial banks are desperate to repair their balance sheets. The Centre for Economic and Business Research predicts that more than 6,000 City jobs will disappear. Loan terms will inevitably become more stringent for everyone: insult to injury for many distressed borrowers is that their mortgage costs will rise even as official interest rates start to fall. At the risk of stating the obvious, this is hardly an environment conducive for growth, whether for businesses or individual consumers.
So why are equity markets so buoyant? Investment banks, and their stock prices, are on the front line of this particular battle and the movement there really doesn’t make much sense. “It seems the more money you lose, the more your shares go up” was how one investment bank executive described the situation last week. The equity markets have been quick to express relief at finally knowing the extent of banks’ credit losses incurred during the summer (results for many were announced last week). But it is less obvious that the credit and lending markets will be back to rude health any time soon – or, indeed, that banks are necessarily being entirely honest about their liabilities, given the extent to which so many holdings are still being priced “to model” rather than to market.
There may well be types of investments – especially high-yield, leveraged and the more opaque structured products – for which there will be a buyers’ strike for some considerable time to come. The idea that investment banking earnings will painlessly revert to their pre-crisis levels requires more than just heroic amounts of wishful thinking. The key thing to note here is that the dramatic spread of credit-risk aversion and subprime contagion this year points to a weakness in theories about globalisation. Investors had assumed that diversification – by product and by geography – would spread risk more thinly throughout the system. It now appears to have done the opposite. Instead, bad risks seem to have ended up concentrated in regions and institutions that one would once never have dreamt of. Worse, globalisation has massively increased the speed by which (bad) news is transmitted – and by which trades are duly executed. There is now a dangerous mismatch between the speed with which hard data about the economy emerges – very slowly – and the rapidity with which markets try to predict the future.
Stockmarkets have been quick to price in the best of all possible worlds. Not only are double-digit year-to-date gains being recorded, somewhat bizarrely, in the US stockmarkets, but as at end September, the Shanghai Stock Exchange Composite Index had delivered gains of 109%, and the Shenzhen Composite had returned over 180%. Did anyone say bubble? Equity investors seem to have decided that emerging markets will pick up the slack from the weaker US economy and prospectively weaker eurozone economy. What if they don’t? What if, instead, lower property prices mean reduced consumer confidence, which, matched with a banking system still licking its wounds, means slower growth in both the West and East? Even if – and it is a big if – lower interest rates in the US help to take some of the sting out of banks’ and consumers’ wounds, they cannot actually mend a badly ailing economy. Instead, they may merely delay the inevitable day of reckoning and accelerate growing inflationary pressures.
Equity markets have long displayed an astounding resilience to fundamentals. Such resilience may continue, but the prudent investor will always look beyond short-term noise to assess the underlying picture. And that looks distinctly ugly.
Tim Price is Director of Investment at PFP Wealth Management. He also edits The Price Report investment newsletter.
FREE! For all our latest advice on making profitable investments, claim your 3-week FREE trial of the MoneyWeek website and magazine now.
This genius investor does dizzying levels of research to uncover...Half Price Shares!
Money Morning is the FREE daily email from MoneyWeek
– a punchy round-up of the latest investment news and profit opportunities.
DON’T MISS IT!
