Personal finance: Stock markets will get a reality check, but when?
It will not be surprising if 1999 does at last see the down year in the US and UK stock markets
Saturday 26 December 1998
As it turns out, rather like 1987, when historians come to look back on the charts for 1998, the crisis of the summer will appear merely as a significant blip, not as a serious or enduring dislocation. Both the US and UK markets look like ending the year showing comfortable gains of around 10-15 per cent, just as 1987 ended with the markets showing a modest rise, despite the great cataclysm in October of that year.
It means that there have now only been two years in the last 20 in which shares have not shown a positive total return, a quite remarkable record of sustained success by historical standards. Just as remarkable has been the continued strong performance of gilts, which in an era of declining inflation are now firmly back in the fold of respectable mainstream assets.
Gilts were the strongest performing asset class in 1998, just as they were in 1997 - and in fact have more than matched the performance of equities over the course of the 1990s, with a string of double-digit total returns. (Who would have thought a few years ago that we would have lived to see the much maligned War Loan selling at 76p in the pound, as it was this week?)
When it comes to looking forward, however, some now all-too-familiar doubts keep crowding in. The IMF, in its latest forecast out this week, specifically identified the risk of a stock market correction as one of the five most important risks hanging over the world economy. I have yet to meet a sensible or thoughtful professional investor who does not recognise the force of that concern. Alan Greenspan, the chairman of the Federal Reserve, has demonstrated his remarkable ability to sustain the confidence of the markets through the liquidity crisis of the summer. But his balancing act cannot continue forever without the risk of another serious mishap.
Knowing that the markets are fundamentally overvalued, but worried at the same time about avoiding a painful collision with reality, Greenspan's problem is that every time he succeeds in deflating one crisis, he merely recreates the problem that exercised him in the first place - which is the risk that an overinflated stock market will create a consumer boom that can only end in tears, just as the property boom of the late 1980s did.
With the world economy having slowed dramatically, and a spate of profit warnings from leading US companies seemingly having little effect on Wall Street, there is every sign that the stock market there is indeed entering a period of unsustainable divorce from reality. A price/earnings ratio of 24 is making an awful lot of positive assumptions about future profits performance, which sit very uncomfortably with the trend of earnings downgrades.
Andrew Smithers, the fund management consultant, observes that, as usual in economics, the issue is not whether but when the stock market correction takes place. The timing cannot be predicted with confidence - and it may take some time yet - but that it will in due course happen is inevitable. It need not be the end of the world, but it could still be quite nasty.
The dilemma for investors in the meantime is what they are to do about it: only a fool will want to avoid enjoying the fruits of the good times while they last, but at the same time prudence suggests it would be unwise to be lulled into the feeling that the stock market can go on delivering returns of 20 per cent a year indefinitely.
Admittedly, there are some consolations around. I note that George Soros, whose public pronouncements I have always found to be an invaluable contrarian indicator, has published a book warning that global capitalism is in serious crisis.
He describes the current bounceback in markets as a "false dawn" that could be followed by "a profound bear market, just as in the 1930s and in Asia currently". If he thinks that things are so bad, then maybe we are indeed poised to live through an economic miracle. The Economist, which also tends to be right about things, but far too early (it has been predicting $10 a barrel of oil since around 1985), thinks that the market is now so overvalued that it no longer makes sense to assume automatically that the stock market is still the best long-term home for savings - an assumption that has become an accepted part of conventional wisdom in the US and, to a lesser extent, over here.
These are all sombre warnings from clever people. The fact is, however, that the great market setback has been predicted with great regularity for at least three years and has yet to happen. Seeing the experts confounded is an enduring and innocent source of pleasure.
It is clear that most of the gloomy market pundits have relied too heavily on the assumption that the market will in time revert to its traditional valuation parameters. They have overlooked the powerful specific forces (which include demographics and co-ordinated disinflationary policies) that have helped to keep this phase of the bull market going for so long. All bull markets, we have long been told, must climb a wall of worry, and this one has proved its credentials in spectacular fashion.
But it would be a mistake to say: "To hell with the pundits, and let's just go with the flow." A couple of months ago I asked Barton Biggs, the highly respected market strategist at Morgan Stanley, what he thought would happen to the markets following Greenspan's latest interest-rate cut.
His view was that "the Fed has panicked". The market would inevitably bounce back strongly till the end of the year, he thought, before reality finally set in one last time. I fear that this time he may be right. Making market forecasts is, as I have frequently pointed out, a mug's game, but I am going to be brave and say that I will not be surprised if 1999 does at last see the down year in the US and UK stock markets that so many have forecast for so long. It will, I hasten to add, be a pleasure to be proved wrong.
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