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A season of financial as well as meteorological storms
By Justin Urquhart Stewart 22/10/2007 00:00
Back in October 1987 the storm that hit South East England acted as the perfect analogous prologue for what was about to hit the stock markets the following trading day.
The monumental drop on the Dow Jones index reverberated around the globe as it plunged 508 points, or 22.6% on what was then record volume and became known as Black Monday. How appropriate then that we should be concerned about this anniversary as the Dow has again been reaching record highs.
That single day collapse in value has to date never since been beaten. The Great Crash of 1929 may have been deeper and longer but there has never been such a single day plunge. However, that damage was far longer lasting and real value was not achieved again until the mid 1950’s. Compare that to the switchback ride in 1987 where the Dow had recovered half of its losses by the end of the year and by December of the following year was nearly 25% higher.
(There was in fact one greater percentage drop of 24.39% back on December 12th 1914, but that was somewhat distorted owing to the closure of the market at the outbreak of the First World War.)
So can the same thing happen again, and is it about to happen now?
Firstly, both economically and politically the world is a very different place with globalisation having opened up closed economies in a way thought unimaginable back then with Russia, India and China now having a significant impact on world trade and investment. This means that investment markets have been spread around the world and are far less concentrated than just on the leading US indices. That’s not to say that there can’t be contagion between them, but there is at least some separation.
Secondly we should consider valuations. The US market although reaching record highs, the trailing price/earnings ratio on the S&P 500 index stood at 22 in 1987 compared to a lower figure of 18 today. Also the Bond market back then was in the depths of a bear market with 30 year yields at 10% compared to a mere 4.87% currently.
Thirdly, after the crash, the NYSE implemented some control measures by way of circuit breakers to halt overheated markets getting out of hand. To date they have yet to have been enforced.
Finally, there was in my view one key area of difference. Both in the UK and US the investing attitude from the prevailing “Yuppies” of the day was one of infallibility. The market was rising and we were the kings of capitalism worshipping at the idolatry of the Stock Exchanges, so what could go wrong? Today many market participants are spooked by fears of impending catastrophe, some of which have already come true with the sub-prime debacle, and in some sense there has been an expectation that something will occur over the next few months. If this is still a bull market, it is one with a nervous tic.
There are still some worrying issues which the sentient investor should be quite rightly concerned about. Inflationary pressures both domestically and imported from China are going to be an increasing concern, along with the ability to cut rates in the face of weakening economies. Pressure on the consumer from both rising costs and a fracturing housing market will dent confidence and thus the opportunity for further growth, and then also the geo-political threats that are ever present but surface into peaks of worry at key moments. Currently the concern over Turkish/US relations and the threat of incursions into Iraq have pushed up crude prices to record levels – never a positive sign for global growth and confidence.
However, maybe it is the concern over increased protectionism by Western nations both in terms of trade and inward investment by the cash rich nations such as Russia and China that could take us to higher level of “Defcon” alert as nations seek to defend assets from Johnny Foreigner – funny though, as I thought that was what we have done to them for decades?
So will there be another crash – yes – but who knows when? Timing the market is impossible but adjusting for risk is always vital – and yes, these are riskier times.
***
So oil has been hitting $88 a barrel, but not many seem to be taking any notice. In fact in real, inflation adjusted terms, the price is closing in on its all time highs recorded in 1980 at the time of the Iranian Islamic revolution. Of course pricing the brown stuff in Dollars does give a rather misleading indication of value, as that currency has declined however, for US consumers and manufacturers these are real cost rises. Of course for those in other currencies such as Sterling, Euro and Yuan then we are still off the earlier peak prices but nonetheless definitely not cheap.
This is inflationary and if Sterling starts to fall back over the coming months then this will add further pricing pressure if the oil price remains high. Last weeks UK inflation data was still benign and may encourage thought of an interest rate cut in the not too distant future However, I suspect Mervyn King and his team will be looking for greater evidence of a slowing economy and for some more substantive indicators that inflationary pressures are in fact easing – I am not too sure that they necessarily are.
***
And finally….published in the Proceedings of the National Academy of Sciences (vol 104, no 24) an award for the team at the Universidad Nacional de Quilmes for their work on the discovery that Viagra aids jetlag recovery in hamsters - this will be excellent news for my hamster.
And also recognition for the team at the Universitat de Barcelona for their cutting edge work in linguistics, which has established that rats sometimes cannot tell the difference between someone speaking Japanese backwards and a person speaking Dutch backwards. Personally I am with the rat.
Who pays for this rubbish?
Have a good week,
Justin A. Urquhart Stewart
Director
Seven Investment Management
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