The sharp falls in global markets over the last month are due to more excessive fear and herd behaviour than any shift in economic and corporate fundamentals. Since their highs in July global stock markets have fallen by more than 20%, driven by a swathe of negative economic data, growing anxiety over sovereign debt and the after-effects of a US rating downgrade. Despite the sharp falls in equity markets, nothing much has changed over the last few weeks. After losing their prized AAA rating, US treasuries still remains a safe haven asset, this is reaffirmed by Moody’s and Fitch commitment to maintain their AAA rating. Anxiety over sovereign debt has been present since 2008 and weak economic data only confirms that economic recoveries following balance sheet recessions are typically slow and protracted. There have been no new significant economic developments that would justify such a dramatic fall in global equity markets in the last few weeks. In my view the markets are now tremendously undervalued, there are three reasons for this.
Firstly in the midst of the recent market falls, economic and corporate fundamentals seem to have been forgotten. Share prices of the top 20 companies in the FTSE 100 (UKX) have fallen by more than 15% where as average forecast earnings have been downgraded by a modest reduction of 1.8% over the last month. Reductions in share prices have been nowhere near modest earnings falls, as a result there are now plenty more bargains available for investors looking to increase equity exposure. On the economic front the Federal Reserve’s survey of US banks senior lending officers last week showed a continued gradual easing in the conditions on which they make loans, the financial sector continues its ‘long hard slog’ to recovery. Purchasing manager’s surveys still suggest positive growth and demand for commodities remains robust. The market falls may be indicative of a slowdown, but a double-dip recession is unlikely and should it occur will be temporary given the growing presence of emerging consumers in countries like China and India. Also it is important not to read too much into the recent sell off because stock markets have had a terrible track record for predicting downturns, as the saying goes stockmarkets have predicted 10 out of the last 3 recessions.
Secondly markets are driven by the interaction of greed and fear. In this case when fear…
Sorry, but this article sounds like complete bunk to me. Just because the market moves in the opposite direction to the author's wishes, he seems to conclude that it must be "irrational" and driven by "emotion" and "panic". An alternative interpretation would be that the author's investment thesis is completely wrong.
There are many significant economic developments that more than justify the falls we have seen. Remember that at the April stockmarket highs, the consensus was that the system was healing and that the recovery would continue. Since then
1. The US has lost its AAA rating from S&P. Not exactly a healthy sign, and one which could have unexpected consequences considering that the whole financial system is built around the assumption that US debt is risk free.
2. It is becoming ever clearer that the Eurozone crisis hasn't been solved, and that its resolution will be extremely unpleasant.
3. QE2 has ended. That means that hedge funds have less cash available to pump up the stock market to ludicrous levels.
4. The Western world has been in a balance sheet recession since the 2008 financial crisis. That means the usual pattern of post WWII recessions doesn't apply. Growth will be weaker, and recessions will be more frequent. Many market participants have been in denial about this, and are now waking up to reality.
5. Whilst some companies have been doing quite well, this isn't likely to continue for companies in general for a host of reasons. Firstly, many Governments have started austerity programmes, which are likely to reduce growth. Secondly, corporate balance sheets are quite highly leveraged. Thirdly, profit margins are at a historical high and are likely to revert to the mean. Fourthly, a lot of the improvement in earnings is due to cost-cutting, which can obviously only go so far.
6. It is becoming clearer that we are entering the second phase of the crisis, which will consist of a series of sovereign defaults by developed countries. Obviously this will have a seriously negative impact on company earnings.
7. Governments have fired all the fiscal bullets they can get away with politically. Central banks are at the zero bound, and QE has failed. They face political opposition to more exotic policy options, which are highly likely to backfire anyway. The Greenspan/Bernanke put is dead.
Other assorted thoughts:
*Analysts have such a terrible record in forecasting earnings, I hardly think it deserves a mention.
*Whilst lending conditions might have improved, credit growth in the US economy has been entirely due to the Fed's QE, which has just finished.
*The author asserts that a double dip recession is "unlikely". I would say that its almost certain given the factors already mentioned.
*The author ignores the ridiculous amount of over investment that has occured in China. How has he managed to convince himself that there's anything sustainable about China's economic model?
*It never ceases to amaze me how market bulls select the valuation metrics to suit their investment case without bothering to look into whether they actually make any sense. Comparing the dividend yield on shares with the gilt yield is a nonsense, and history has shown that it has no predictive value. The best valuation metric to Tobin's Q, and the second best one in the Shiller 10 year PE. These show that the stockmarket is actually greatly overvalued, even after the recent falls.
I agree that this isn't a repeat of the 2008 financial crisis - it will be worse. The real wonder is not how much the market has fallen recently, but how much it went up from the March 2009 low in the first place. In reality, is the opportunity of a lifetime to reduce risk exposure.
