Jeremy Warner: Whither bombed-out equity markets?

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The Independent Online

Outlook Not since the dotcom meltdown has there been a year of such carnage in the stock market. In most respects, the current bear market is much worse. The speed of it resembles more of a crash than a prolonged correction. Its other distinguishing feature is that it has hit mainstream companies with equally devastating effect – not just overvalued technology, telecoms and media stocks, as the sell-off did in the early Noughties.

Only 10 stocks in the FTSE 100 rose last year, and most of those by not much at all. The best performer was Randgold Resources, whose attractions as a producer of gold only quite recently propelled it into the FTSE 100. The only other performer of any note was the nuclear power stations operator, British Energy, the subject of a bid from Electricité de France.

Banks were clobbered, with one of their number, HBOS, ignominiously joining the "90 per cent club" – that is, stocks that have lost 90 per cent or more of their value over the past year. But even Barclays lost nearly 70 per cent of its value. Will the banks be forced to take yet more of the Government's money in the coming year? That's the fear that continues to stalk any near-term hope of a recovery in bank share prices.

Nobody yet knows the answer to this question, though, ominously, I gather all UK banks have been required by the Financial Services Authority to draw up an updated year-end schedule of likely bad-debt exposures, using a worst-case scenario basis.

Personally, I have trouble in seeing why requiring the banks to raise more capital is going to do any good when it is as much an absence of liquidity with which to lend as capital against which to lend that is the root of the problem.

A better solution all round would be the sort of "quantitative easing" we are seeing applied in the United States, where the Government through the Bank of England would wade into the market to buy up corporate and mortgage debt, thus releasing capital to be applied to new lending. In any case, the conflicting demands of the Government, which wants the banks to lend more, and the markets, which want the banks to deleverage and get their balance sheets back in order, remain as acute as ever. Banks find themselves being pulled both ways.

Still, bank shares have already sunk so low that further dilution of shareholders, or even total wipeout in wholesale nationalisation, may not affect the overall value of the FTSE that badly.

There are plenty of reasons for being gloomy about the coming year. We are bound to see a whole host of further insolvencies, including a number of prominent household names. The recession is surely likely to claim another high-street brand as resonant as Woolworth's before it has runs its course. I've got my own view on which one, but the law of libel prevents me from saying.

Also inevitable is the uncovering of that other defining characteristic of a serious downturn: a major fraud. Thus far there has been surprisingly little evidence of it beyond the pantomime-like figure of Bernie Madoff – unless you count the banking debacle as a whole as just one gigantic fraud.

But though banks have undoubtedly been guilty of stupidity, recklessness and greed on a monstrous scale, so far the authorities haven't yet managed to pin any substantive case of lawlessness on them.

Outside Madoff, there has as yet been no defining, Enron-style, case of fraudulent deception. It's a racing certainty that this year will bring news of one. As the tide recedes, you get to see the wrecks that lie beneath.

Yes indeed, there are plenty of reasons to be gloomy, but the stock market may not be one of them. Stock markets tend to anticipate recovery long before it happens, so, assuming the authorities have got the policy response right, by the end of the year share prices should be bouncing sharply. As things stand, they discount not just a recession, but more of a deflationary depression of mass insolvency and long-term corporate contraction.

As stock markets plummeted last year, government bond markets rocketed. Ever since the late 1950s, with one or two shortlived aberrations, equities have consistently yielded less than bonds to reflect their perceived attractions as a hedge against inflation. Unlike bonds, equities have potential for capital and dividend growth.

Yet some time last year, this "reverse yield gap" swung back the other way. Equities now yield more than bonds by quite a margin. Either this is again an anomaly, or we are indeed heading into a deflationary world in which the only safe place for your money is government bonds.

Take your pick, but I'm inclined to the view that equities are not yet an entirely dead parrot. To the contrary, with debt in full retreat, equity becomes a relatively scarce and therefore valuable form of capital that can expect to command a premium to match.

I was wrong about equities this time last year, so my predictions may deserve to be taken with a large pinch of salt and certainly carry the customary health and wealth warning. In any case, hold on to your hats. Whatever the outcome, it's going to be a turbulent 12 months.

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