Jeremy Warner's Outlook: Real killer for equity values is not the earnings outlook but the debt overhang

Another cocktail of bad news from the housing market yesterday shouldn't be allowed to hide the fact that on a 10-year view housing has remained a much better investment than the stock market. Even in the extreme circumstances of a 40 per cent correction in house prices – a level of adjustment without precedent in the post-war period – you would still have been been better off sinking your capital into UK housing than UK equities.

Gilts too have produced a better rate of return on a 10-year view. Despite an almost unparalleled period of growth and prosperity, UK shares have ended up no higher than they were 10 years ago. Worse, they now appear to be heading lower still.

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Small wonder, then, that the cult of equity is being pronounced by some pundits as well and truly dead. We now seem to be entering the second bear market of the period, or even third if you count the "mini-crash" of the Russian debt crisis in late 1998.

In the meantime, share prices haven't even managed to rescale their turn-of-the-century peak. This extreme volatility is persuading even die-hard stock market investors to give up on equities. The way things are going, the stock market will become the playground of speculators alone, a super-casino where shares are treated as no more than gambling chips in an unsophisticated game of bluff and luck.

As share prices fall ever lower, a familiar problem which had been assumed cured is returning to haunt corporate Britain – the pension fund deficit. Most big pension funds are now closed to new membership, but, for many companies, the legacy liability remains. Right now, it is growing bigger by the day.

Should we be keeping the faith or abandoning all hope? Looking at the wider economy, the main driver of bearish sentiment has become fear of an extreme consumer slowdown. Nobody can yet say how bad this is going to be, but with fuel and food prices soaring and credit ever scarcer, it is hard to argue a positive prognosis.

This in itself is going to have a severely negative effect on corporate profits. In highly indebted companies, there is a multiplier effect, where banking covenants are breached, forcing extreme equity dilution through rights issues or debt-for-equity swaps. This is why we have seen equity values virtually wiped out at some companies. The phenomenon is caused not so much by the likely fall in earnings as by the fear that covenants will be breached, prompting a refinancing.

The same worry is driving the now extreme fall in bank shares. Impaired capital ratios as bad debts mount are forcing repeated recapitalisations. Some banks may have to come back for a second helping, or even a third. As a consequence, a generalised aversion to equity has developed, even among those with cash piling up in the bank ready for investment.

Bankers have hardly helped themselves by being less than candid about why they are raising new capital. Is it to pay for past bad debts, prepare for new ones, or to fund future growth? Sometimes it seems that bankers themselves don't know the answer.

Certainly, the message they deliver is a deeply confused one. Yet in the end, everything has its price. The bottom of the bear market of the early-to-mid 1970s was marked on 4 January 1975 when institutional investors stuffed to the gunnels with uninvested cash collectively decided that they risked losing the lot if they allowed the collapse in prices to continue any further. This time around, that point has not yet been reached. The FTSE 100 is still less than 20 per cent off the peak of a year ago. But in time, it will arrive. The point to buy is when everyone else is giving up. Just remember. If you had held shares since 1975, you might even have beaten housing.