Global Markets Weekly - 5th January 2009
- Last year was the worst for US equities since 1931…
The New Year is a time not just for making forecasts but also for reviewing the past, and few investors will recall 2008 with pleasure. In most major developed economies, it was the worst year on record for equity markets. In the US, where figures are available for over 100 years, it was the worst year since 1931.
- …but 1932 saw the bottom for the market…
At the end of 1931, the US was still at the start of the Great Depression: economic activity, employment and price levels would all trough at lower levels over the following three years. To an investor with anything other than a very short time horizon, however, it was also a good time to begin feeding money into equity markets.
- …amid significant short term volatility…
Like today, valuations then were attractive. Yet, also like today, they offered little
support to short-term investors. Indeed, the market remained extremely volatile in 1932, falling 25%. The trough in the US equity market came that July, pre-empting the end of the debt deflation cycle by around six months.
- …before equities rallied as investors began to anticipate higher future earnings.
So, in Our own work using more recent data suggests that valuations are a significant driver of returns only for holding periods of three years or more . This result even holds when tested for the Great Depression. Buying the Dow Jones at the end of its 1931 annus horribilis would have produced a total return over the next three years of 30%. Significantly, almost all of this three-year performance (25% of the 30%) was driven by revaluation rather than earnings improvements. Even in the midst of the Great Depression and after a series of catastrophic policy blunders, equity investors began to anticipate higher future earnings. However, in order to start pricing in earnings improvements in 1932, investors had to be able to foresee an end to the debt-deflation cycle.
- Today, the economic outlook remains bleak…
Returning to today, data last week suggested that the deflationary forces buffeting the global economy remain as strong as ever . December's reading of the widely followed Institute of Supply Managers' survey in the US was the lowest since 1980, consistent with a severe contraction in industrial output. The prices paid component, that had been indicating
rapidly rising input prices earlier in 2008, was at its lowest level since 1949 - a year in which headline CPI inflation reached -3%.
- …with poor housing data and dismal consumer confidence.
Meanwhile, US house price figures came out weaker than expected , showing a decline of 18% in the year to October. Almost all US household wealth is held in houses and equities, so it’s little surprise that, with the price of both assets having fallen steeply in 2008, consumer confidence for December was historically low.
- Yet much bad news is now already priced in…
Interestingly, however, retail stocks reacted to the news by staging a rally . Bellwether retail stocks such as Macy’s and Tiffany & Co. were among the best performers on the day, up 6% and 7%, respectively. Hence, though plenty of deflationary news remains in the pipeline, much of it is already priced in. As in 1932, it is this nexus of valuations and economic outlook – not either in isolation – which will determine the timing of a sustainable rally in equity markets.
- …which offers us some reassurance.
So, looking at the early 1930s, the true lesson for today’s investors is not one of abject despair . Rather, as Winston Churchill wrote, ‘while we cannot know the future, the past should at least offer us reassurance.’
Indices, Interest rates and Inflation
|
Close -02-Jan-09 |
1 Week% |
1 Month% |
3 Months% |
YTD
% |
|
FTSE ALL Share |
2,275 |
7.8 |
10.8 |
-8.0 |
3.0 |
|
FTSE 100 |
4,562 |
8.2 |
10.7 |
-6.3 |
2.9 |
|
S&P 500 |
932 |
6.8 |
9.8 |
-16.4 |
3.2 |
|
Nasdaq Composite |
1,632 |
6.7 |
12.6 |
-17.4 |
3.5 |
|
DJ Stoxx (Europe) |
231 |
6.4 |
7.1 |
-17.4 |
3.5 |
|
Nikkei 225 |
8,860 |
1.4 |
12.7 |
-20.6 |
0.0 |
|
Hang Seng |
15,043 |
6.1 |
12.2 |
-17.4 |
4.6 |
| Official Rates (%) |
Inflation (%) |
Rate announcement |
|
Current |
Mar-09 Forecast |
Jun-09
Forecast |
Current |
Next Date |
|
US (Fed Funds) |
0-0.25 |
0-0.25 |
0-0.25 |
3.7 |
28-Jan |
|
UK (Base rate) |
2.00 |
0.75 |
0.50 |
4.5 |
08-Jan |
|
Euro-zone (Repo Rate) |
2.50 |
2.00 |
1.75 |
3.2 |
15-Jan |
|
Japan (Call rate) |
0.10 |
0.10 |
0.10 |
1.7 |
22-Jan |
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