Wall St gyrations likely to keep nervous investors on sidelines

STOCK MARKET WEEK
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The Independent Online
Stock markets on both sides of the Atlantic were dominated last week by the spectre of history repeating itself as fears of a rerun of the 1929 or 1987 crashes kept investors on the sidelines.

The more superstitious of them were no doubt alive to the fact that previous collapses had occurred about 40 trading days after shares hit their peak. Wall Street, readers will recall, reached a record high of 5,778 on 22 May. Small wonder both New York and London wobbled again.

Adding to the doom and gloom have been a clutch of investment gurus, ever keen to justify their existence and salaries. Five weeks ago Gail Dudack, senior US equity analyst with UBS, predicted a 16 per cent sell- off on the Dow. In April, Byron Wien, a market strategist at Morgan Stanley in New York, predicted a 1,000 point fall. And last week Elaine Garzarelli, credited with calling the 1987 crash, warned US shares might fall by up 20 per cent from recent peaks.

With the FT-SE 100 still only 5 per cent below its all-time high of around 3,850 and Wall Street 7 per cent adrift, the worst may be yet to come.

That is certainly the view of London-based economic consultant Andrew Smithers, a stock market bear since the end of 1993, who thinks a correction of up to 50 per cent is on the cards. He notes the stock market has only reached peaks comparable with today's levels on three previous occasions. Each peak, he says, was followed by a crash, followed in turn by a severe recession.

Given that policy-makers - governments and central banks - are primarily concerned about the price of goods and services, rather than stock market indices, Mr Smithers thinks everybody, not just investors, should be concerned.

"There is a major asset bubble in the US stock market," he warns, "and the market is now probably more overvalued than it has been previously this century. The level of the stock market is so excessive that it provides a significant risk for the real economy, as well as for the financial one."

In other words, buoyant share prices matter not just to investors, but to the wider economy as a whole. The stock market is important precisely because it is a leading economic indicator. Forecasting the economy and then drawing conclusions for share prices puts the cart before the horse.

It was all so different 50 years ago. The old Keynesian, post-war consensus assumed that central banks had a duty to avoid creating asset bubbles. The searing experience of the 1930s depression, following hard on the heels of the 1929 Wall Street crash, was generally accepted to be one of cause and effect.

But fear of asset bubbles bursting receded as the problem of deep and protracted recession increasingly became one of cure rather than prevention. If lower interest rates did not stimulate growth then recovery could be achieved through fiscal stimulus, so the theory went.

But Mr Smithers argues that in the US low household savings and a high rate of personal debt defaults make it likely that a looser monetary policy alone would not be enough to kick-start a post-crash recovery.

And with both Republicans and Democrats committed to cutting the budget deficit, any fiscal stimulus could well be delayed. In other words, a US recession set off by a bursting asset bubble could be unusually severe.

"Asset bubbles are dangerous because the subsequent process of readjustment involves either a fall in nominal asset prices leading to bankruptcies or recession, or a resurgence of general inflation." Put another way, asset bubbles threaten not only financial loss and share price volatility but also sharp swings in the economy.

He highlights the Japanese experience over the past four years, which has shown it takes time and a massive amount of fiscal stimulus to resuscitate a post-bubble economy. If Wall Street caves in, he sees a significant risk of a second collapse in Japanese share prices. These will reinforce each other and create a worldwide recession. Ouch.

The only comfort for investors is that when the economists form such a bearish consensus good times can only be around the corner.

The reporting season seems to get earlier each year and over the next fortnight almost a fifth of the top 100 companies will be announcing results. The main focus will be on the banks and oil companies.

National Westminster gets the banks' season under way on Tuesday with a reported fall of 63 per cent to pounds 321m, heavily distorted by one-offs such as the pounds 690m loss on disposal of NatWest Bankcorp. The underlying picture should actually be quite encouraging with a rise before provisions of about 11 per cent.

A busy Wednesday sees BAT, Glaxo Wellcome, Cowie and Guardian all issuing interim reports. BAT's first-half figures (profits of pounds 1.29bn) are expected to disappoint anyone looking for a strong tobacco growth story. Cigarette profits are expected to grow by only about 2 per cent in the first half, rising to maybe 6 per cent for the full year.

In financial services, strong new business at Allied Dunbar is expected to be offset by a deterioration in trading conditions at Eagle Star, the general insurance arm.

Attention will focus on Glaxo Wellcome's recent good news on its Epivir Aids treatment, where better-than-expected results prompted the early termination of a trial so patients could stop taking a placebo and instead benefit from the drug itself.

According to NatWest Securities, earnings growth is no longer dependent on cost savings alone. A raft of new product introductions will help offset sales declines due to the expiry of Glaxo's patent protection for blockbuster ulcer treatment Zantac. Profits should rise 21 per cent to pounds 1.39bn.

Another full reporting day on Thursday will see an encouraging first- half message from oil explorer Lasmo. Despite frustrating delays to its two major projects in Liverpool Bay and Algeria, Lasmo's first-half performance has been more than satisfactory, setting the scene for further gains later in the year. Expect broadly unchanged profits of pounds 23.3m.Shell will also present an upbeat report on Thursday, with profits of pounds 1.26bn, up 9 per cent.

NatWest Securities forecasts good interim numbers from engineering group TI on the same day, with strong cash flow setting the company up for further bolt-on acquisitions. Profits should jump from pounds 87.4m to pounds 98.5m.

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