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*** Misery loves company in the markets
*** Rover’s deferred demise…where the blame really lies
***trying to be optimistic…stagflation…and more
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- Following the worst week for London shares since last July, with the FTSE sliding by 1.8%, investors were hoping for a respite on Monday. They didn’t get it. The blue chip index fell by another 1.3% to 4,827, having hit 4,794, a 12-week low, during the day.
- Misery loves company, however, and London was far from alone. Japan’s Nikkei posted its biggest plunge in 11 months, losing 3.8% and dropping below the 11,000 level for the first time in four months. Germany’s DAX index lost 2.6% yesterday, and has now relinquished its 2005 gains. And the MSCI Emerging markets index lost 1.8%, adding to a 3.8% decline last week.
- Markets were taking the lead from Wall Street, where the Dow Jones index finished last week 3.6% down, its worst week in over two years thanks to jitters over economic and earnings weakness amid soft retail sales, confidence and manufacturing data. Poor results from technology bellwether IBM last week and industrial and consumer products conglomerate 3M on Monday also fuelled concern that consumers are running out of steam.
- All sectors of the UK market retreated, with the traditionally defensive healthcare industry faring best, losing just 0.32%. The only notable rise in the blue chip index came from ITV, lifted by weekend reports that it could become the subject of a bid. It gained 1%.
- Meanwhile, Rover’s former directors have come under pressure. The government has called in the Financial Reporting Council, which regulates company reporting procedures, to investigate just how much money Phoenix Venture Holdings extracted from the car maker. The four directors made about £40m in pay and pension contributions, and some reports have claimed that as much as £400m is unaccounted for in Rover’s finances.
- Yet it’s no good the government suggesting the car maker wouldn’t have collapsed if the directors hadn’t been greedy, as Anthony Hilton pointed out in yesterday’s Evening Standard. The real story here is that the government ensured that Rover was sold to Phoenix rather than to another venture capital group that had planned to keep only the MG Sports car arm and shut the rest. Phoenix’s plan, conversely, was to keep Rover going as a mass manufacturer, even though Rover’s small size and ageing models meant this was a hopeless task. But the trade and industry secretary at the time, Stephen Byers, went for it to avoid political heat for redundancies. “His cowardice meant the demise of Rover was deferred, and when it came it was even more painful”.
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- It’s been hard to remain optimistic in the face of the torrid sell-off on Wall Street. But James Paulsen of Wells Capital Management had a go. He pointed to the prospect of double-digit gains in some companies’ earnings this quarter, and noted that “the impact of a positive profits surprise could be greater than it would have been” this week now that last week’s jitters have lowered expectations.
- That hardly amounts to a screeching buy signal. With profit margins at 50-year highs, there seems scant scope for strong earnings growth to give the market a further boost. Overall US earnings growth is currently expected to reach just 6% this year, notes Edward Hadas on Breakingviews.com, and that could be optimistic in view of the fading growth signalled by recent data and high oil prices, which will feed through into higher costs. The overall environment is beginning to look stagflationary, as oil prices and the weak dollar fuel inflation but the economy slows.
- So what’s gone wrong with the economy? The rebound was never very convincing because the excesses of the bubble were never fully corrected: America slashed interest rates and showered the consumer with tax cuts to avoid a deep recession. As Alan Abelson puts it in Barron’s, a hangover was treated with a binge. Widespread overcapacity was never eliminated, which is why companes have been so loath to hire and expand-crucial ingredients of a strong rebound-since 2001. And now it looks as though indebted consumers, which kept spending through the recession and have virtually no savings, are finally running out of steam.
- Stock market valuations also suggest that the post-2000 bear market has unfinished business. Two centuries of market history show that markets alternate between long-term (eight to 17 year) up and down cycles - secular bull and bear markets. In the latter, valuations fall below the long-term average to extremely cheap levels, setting the scene for the next secular bull, such as the 1982-2000 run-up, when valuations rise above the average. US price-earnings ratios have yet to fall below the average post-2000, so further slides - or a long period of sideways drift as earnings catch up with valuations - are on the cards.
- It’s been a similar story in the UK, where, as market historian David Schwartz points out, fifteen-year upswings such as the massive run-up of the 1980s and 90s are followed by 15 years of underperformance. Chances, are, then, that the rally of the past two years in the US and the UK has been a short-term upswing within a long bear trend.
Until next timeAndrew van Sickl
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