A small bear drama disguised as a crisis

Though such sectors as telecoms and IT have dived during the present UK shares downturn, others like tobacco, personal care, food and drink and commercial property have thrived. Though serious, the shake-out is relatively minor compared with previous crises

Nervous investors have been reaching for their telephones and keyboard mice in an effort to cut their losses, and even hardened market players are checking up on past performance records before deciding whether to press the panic buttons.

Nervous investors have been reaching for their telephones and keyboard mice in an effort to cut their losses, and even hardened market players are checking up on past performance records before deciding whether to press the panic buttons.

Leading share prices have fallen roughly 20 per cent since the FTSE 100 share index reached its all-time peak at the end of December 1999, making the shake-out the sharpest since the crash of October 1987, when shares fell by more than 30 per cent in a matter of weeks.

The current down-turn is now bigger than the Asian markets crisis in the autumn of 1997 and the shake-out caused by the 1992 sterling crisis, when share prices fell about 15 per cent. But there have been similar falls in excess of 20 per cent over the past half century, most of them associated with sterling crises and deflationary policies - and most now forgotten.

There have also been several more critical episodes in the longer-term stock market history - notably in 1929-31 before stock market indices were invented, in 1938-40 when war clouds were gathering and prices fell by more than 50 per cent, and again in 1972-74 when, triggered by the collapse of the Barber boom and a global leap in oil prices, prices plunged by more than 60 per cent over almost three years.

Historically, the current bear market is still a moderate one, somewhere between a shake-out and a slump but well short of a disaster. The 100 Share index would have to fall at least another 10 per cent before historians need to cast around for a name for the episode.

But the pattern of events does deserve close scrutiny. Unlike the crash of 1987, which was sharp but short, the current downturn has lasted for more than a year, and the partial recovery in the second half of last year has given way to a fresh slide.

What also makes this setback different to 1987 is that it has happened when the UK economy has been enjoying a relatively long period of quite steady growth, with low interest rates and low inflation.

If however it has been caused by fears of a coming recession in the US spreading to the UK and Europe, then things may get worse before they get better. The continued failure of the Japanese authorities to halt their own 10-year recession and stock market slump is also unsettling.

A sustained rally in oil prices after last week's decision by oil exporting nations to cut their production levels will not help matters either, and much now depends on how President Bush presents his tax cuts, how the chairman of the Federal Reserve Board, Alan Greenspan, uses interest rates, and whether investors on both sides of the Atlantic view these measures as reassurances or as warnings.

Mr Greenspan must be pondering the ungratefulness of markets, following their precipitous response to his half-point rate cut on Tuesday night. Most commentators were expecting a .75-point cut, with others urging a full 1 per cent to restore confidence.

Mr Greenspan may have been holding back to give himself more room for cuts later, but it would seem that, for now, the bears will not be easily placated. The other key feature of the present phase is that to date it has been concentrated in a handful of sectors that have suffered more severely than the market average.

Since the beginning of last year the telecoms sector has fallen by over 50 per cent and the IT sector by more than 60 per cent. Over the same period the tobacco sector has gained almost 60 per cent and personal care by over 50 per cent. This is misleading because these two sectors contain just three and two stocks respectively.

But much bigger sectors of the economy, including the banks and general insurance, are roughly where they were back in December 1999, pharmaceuticals are about 10 per cent ahead, while food and drink manufacturing and retailing, and commercial property - the sick man of the stock market for most of the Nineties - are all up by about 20 per cent.

This pattern is mirrored in the smaller companies sector. The Alternative Investment Market, with its high proportion of hi-tech stocks, is down by nearly 40 per cent overall, but the fledging and small capital sectors of the main market are roughly where they were at the beginning of last year.

The collapse of the hi-tech sectors should be no surprise to investors who have been following the majority of stock market pundits over the last 12 months. These sectors are at the growth end of the global economy, but last year's share prices had anticipated future profits growth far out into the 21st century, making them vulnerable to any economic slow-down.

Over a 12 to 15-month period the "old economy" stocks that were out of fashion during the bull market have shown much greater resilience. But a closer look is less reassuring. Oil, pharmaceuticals, utilities, food retailers and insurance sectors reached peaks last autumn and have since fallen back by between 10 and 20 per cent, and the banking sector has also eased after peaking as recently as last month, leaving only tobacco, construction and commercial property close to their cyclical peaks.

Share prices have comfortably outpaced the growth of the economy as a whole over the past two decades as the level of company taxes has declined, labour costs have been reduced and profits have increased their share of the national cake. But that adjustment could now have ended and global competition will ensure that future profit growth is harder to earn.

The 100 Share index is still priced at just over 20 times current earnings, which, historically, is relatively expensive, especially if inflation remains within the Government's target level.

Meanwhile gross dividends are averaging about 2.5 per cent a year, twice covered by earnings but little more than half the current yield on UK government bonds.

The big question is whether these earnings will be increased or even maintained. The answer should come in the next six months, and the chances are that it will be found in sectors such as banks, pharmaceuticals and retailing and engineering rather than in the hi-tech sectors, which are likely to take much longer to recover.