Stock market outlook

I have been in the stock markets since 1960.  Bearish markets can be awful.  They make fools of us all, who have taken a sensible, rational approach to forecasting earnings and assets. But they always end; there is money to be made when the bottom is left behind and there is no need to let fear dominate everything we do.  Where are we now?

The bear of 2008

This market now has well known features.  But are those characteristics telling us to be ready to buy?  Housebuilders, banks and retailers have been depressed to extreme levels and may be worth accumulating.  The Investors Chronicle Confidence Index has given its gloomiest reading ever.  Selling a house has become a matter for rejoicing! Financial news, from both the US and UK becomes more alarming as each week passes. Inflation, led by oil prices, is now the concern of the Bank of England and prevents further cuts in interest rates.

It is hard to imagine the mood of gloom in stock markets getting much worse.  But is it all justified? What signs should we look for to guide us towards an improvement? Most important of all, can the UK avoid a recession?

2009: Will the UK recover?

Many economists rely over long periods of time on the inherent ability of the economy to grow somewhere between 2-2.5% annually.  For 2009 most forecasts have been pulled down first to under 2% and then gradually to lower than 1.5%.  Even 1% seems possible.

Investors, consumers and companies respond initially to the threat of setbacks by drawing down on savings.  They did that in the first few months of 2008 and we do not yet know if the period ahead will see a continuation or revival of that trend.

But investors, and traders in particular, should remember that past evidence suggests that bear markets bottom-out when there is a recession.  The oil price shock may not prove strong enough to do that on its own.  If savings are used and banks revive their lending activities, any recession may prove to be mild and that would help share prices recover from their extreme oversold conditions that we see now.

How will recovery develop?

There can be little doubt that some major swings between sectors are likely to occur in the weeks ahead.  It is almost as if the massive moves of a few years ago are likely to repeat themselves, when the internet stocks collapsed and the dull, value shares rallied.

Investors and traders are now heavily into mining shares all over the world.  They have been the only sectors showing relative strength and while I am a long-term bull of the Chinese growth story, many mining stocks look expensive.  Profit-taking occurred recently and many have come off their top levels.

By contrast the valuation on banks, housebuilders and retailers appear extremely oversold.  They cannot be justified on rational analysis.  Hedge funds, in particular, go long on the miners, whilst shorting almost everything else.  How that contrast is sorted out will determine the manner of the market’s bottoming-out process in the UK.

Traders especially should watch this process developing.  It is impossible to estimate the timing of changes in direction.  But there will be plenty of guidance from the relative movement in sector strength during the rest of the summer.  Timing is perhaps the hardest factor to judge in stock markets, but there are usually plenty of signs to show the way the trends are beginning to move.

It is going to be a tough bear market. But the signs should soon be seen as to the direction that recovery will take place.