Stock Market Week: Markets should escape a crash with a few bruises
Monday 27 September 1999
A few months ago, this question would have been pointless. Back then, global equities were riding on the crest of a wave, sustained by widespread faith in the mythical Goldilocks scenario of strong growth and low inflation.
But over the past few weeks the world's major markets have been unnerved by the disturbing thought that the bull party might, after all, be coming to an end.
Over the past few sessions, the Dow Jones, the all-important US bellwether, has lost some 500 points - more than 4.5 per cent of its value - while our own FTSE 100 has plunged around 7 per cent in less than three weeks.
The short-term reason for these jitters is, inevitably, the fear of another hike in rates at the US Federal Reserve meeting on 5 October.
However, after weeks of speculation and market falls, a rate increase in the US should be all but priced into equities and some Cassandras are pointing to some worrying comparisons with the 1987 precedent.
Tempting as the 1987/1999 parrallel is, my hunch is that the domestic equity market is in a better state now than in the pre-crash days.
Those old enough to have traded in the months preceding that ill-fated October will remember a rampant FTSE All Share, which had soared some 80 per cent in a year.
Such a growth rate was clearly unustainable over a long period of time and the crash was a dramatic and violent signal that equities had run out of breath. The present market does not seem to be in such an excited state.
As a recent study by Robert Buckland and Jonathan Stubbs at Salomon Smith Barney shows, the present bull market has underperformed its older brother by around 60 per cent.
The bears normally counter this point by growling that on a valuation basis, equities are much more expensive than in 1987. This is factually true. The UK market's current price/earnings ratio is around 24-times, well above the 18-times of the pre-crash era.
But absolute valuations are not much of a guide to investors' behaviour. Equities might look expensive when compared with their past, but they might still be a better investment than other assets such as bonds. In relative terms, UK stocks are still better value than gilts and their valuation is well below the 1987 levels. This is an important bull point for the stock market: if shares are more attractive than gilts, investors will have little alternative but to put their money in stocks.
The interest rate parrallel is more worrying. As in the summer of 1987, the Bank of England signalled the turn in the cycle with its decision to raise rates to 5.25 per cent earlier this month.
But, even if this is the end of a long rate-cutting era, a series of gentle tightenings in monetary policy will not be enough to trigger a stock market crash.
Overall, the comparison between 1987 and 1999 looks pretty flimsy and there is little to suggest that we are heading for a domestically-generated stock market meltdown.
The real threat of a sharp correction in equity markets comes from the US. There, the similarities with 1987 are more marked; the stock market's growth rate is not far off its 1986-87 counterpart, equities look expensive compared with bonds and the economy is still booming, fuelling fears of inflation and interest rate rises.
Most hopes of a soft landing for US equities hinge on the success of the Fed's attempts to ease inflationary fears by slowing down the frothy American economy. If Alan Greenspan and his colleagues can do the trick, the stock market will probably suffer a few bruises from the inevitable rate hikes but will avoid the major injury of a crash. But if they don't, brace yourself for a long bear party.
This week will provide a litmus test of the state of UK equities as a thin results schedule will force traders to concentrate on the big picture.
The few companies reporting figures will do their best to catch the market's attention. Bank of Scotland will steal the show on Wednesday. The presentation of interim numbers will be a pre-text to discuss developments of its audacious pounds 21bn bid for National Westminster. The pre-tax profit figure, expected to come in at around pounds 446m compared with pounds 420m last year, could be used as further evidence of BoS's claim that its financial performance is far superior to NatWest.
Rising bad debts will be an area of concern. Stephen Kirk at Deutsche Bank expects a first-half provision of around pounds 180m compared with pounds 116m in 1998, driven mainly by the rise in unsecured personal credits. On the plus side, net interest income - a central plank of the bank's earnings - is set to have remained buoyant and should have risen by nearly 10 per cent in the half.
BoS is the only blue chip on the results schedule, although a former FTSE 100 member, Smiths Industries, reports full-year results on Wednesday.
The aerospace and medical equipment group was kicked out of the leading index a couple of weeks ago after a slide in its share price and will have to convince the City that it deserves to return to the market's top flight.
The yearly figures should go some way to restore the Square Mile's faith in the company. Pre-tax profits should come in some 7 per cent higher at pounds 235m. The aerospace division will be the group's high-flyer and should account for a large chunk of the profit rise thanks to increased sales, mainly to Boeing and military aircraft makers.
The medical division, whose products include operating tables and surgery equipment, is set to disappoint as margins continue to be eroded by its research and development spending.
The growing band of Internet investors will wait for Freeserve's first quarter results, due out tomorrow, with bated breath. Over the past few sessions, shares of the free Internet provider, of which Dixons owns a large stake, have plunged below the 150p offer price amid concerns over the number of subscribers.
A few brokers, including WestLB Panmure - one of the few houses to advise caution at the time of the float - believe that Freeserve is not attracting enough customers and argue that the shares are worth a mere 60p.
However, rival brokers say that the dip in subscription is just a seasonal blip and predict that Freeserve was able to mantain its share of the Internet market during the quarter.
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