As 2008 drags on it will not be remembered with fond memories by equity investors. It looked as though the rescue of Bear Stearns in March was going to be a turning point. The Federal Reserve had drawn a line in the sand that things were not going to get worse and that the worst of the credit crunch was behind us. Equity markets rallied into April but fell back again as the realities of the global economic situation set in.

In the last issue we showed a table of the falls in major equity markets from their peak to the latest low. We have updated this here and it shows that markets are now down between 22% in the US and 62% in China at time of printing. The falls have occurred in all major markets and investors have struggled to find a hiding place.

With bank capital in short supply both consumers and corporations are struggling to get access to credit, and this is putting a drag on the whole economy.

Not only are consumers finding credit hard to come by, they are paying more for basic goods that have been pushed up by higher commodity prices. Whether filling the tank with petrol or doing the weekly food shop, people are paying more. As the economy slows the increased cost of living cannot be compensated for with high pay rises, as companies are simply unable to pay more. All this has meant that consumer confidence is falling in most countries.

To add to the consumer woes a good number of people are finding that their largest asset, their house, is now falling in value. US house prices continue to fall, and the UK is not far behind as are the housing markets of Ireland and Spain. It looks as though house prices will have to fall by a considerable amount before the market reaches a bottom. Just as when the market was on the way up the majority view was that it would continue to rise, there now seems the reverse scenario where prices are expected to keep falling.

Government intervention to try and change this seems doomed to failure until the market hits a natural bottom.

Against this backdrop companies are struggling to achieve the kind of earnings and profits that would prop up their stock price. Even the materials sector that has done so well until the middle of the year is now suffering. The conventional wisdom was that China and other developing countries would continue to consume raw materials at an ever-increasing rate, pushing prices to continual record highs. This started to turn in July with the growing realisation that a slowdown in economic output would reduce demand for raw materials no matter how fast China was growing.

Since then we have seen commodities prices fall across the board. The oil price was the one to catch most headlines as t fell from US$145 a barrel to around $100 in just a few months.

Figure 2 captures this as it shows the MSCI World Materials sector and World Energy Sector against the MSCI World Index for 2008. Both sectors significantly outperformed the benchmark in the early part of the year, but since July have fallen back in to line with the main global index.

Maybe the negative sentiment that investors have towards equity markets can be best illustrated by the reaction to the recent US government intervention in the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, better know as Freddie Mac and Fannie Mae. This was one of the largest government interventions of all time. In theory the ove has added almost 50% to the US government’s national debt. Yet despite such a bold move the equity markets were largely unfazed by the whole episode with a short term bounce petering out after a couple of days. Most markets are still down for the month of September. Compared to the euphoria that greeted the rescue of Bear Stearns this has been almost a non-event. In erms of actual scale of capital involved this makes the Bear Stearns episode look like small change.

Whilst investors are so negative on equities as an asset class it seems hard to predict a rally. Of course the counter rgument to this is that only when investors have abandoned the asset class and expect further downward pressure is the time when value can truly be found in the asset. I suspect that we are not quite there yet in the equity markets but we are moving towards it. The Harmony portfolios that we run are staying underweight equities, but we remain mindful that when markets turn they do so very quickly and often the catalyst for the change is not immediately recognised at the time.

 

 

 

Martyn Simpson is the Head of Advisory at MB Asset Management International. For more information on balancing your portfolio, please ontact your local adviser.