In October 1996 the S&P 500 rose above 700 for the first time and by December of that year had gained 21 per cent. That prompted Alan Greenspan, the Federal Reserve chairman at the time, to talk of irrational exuberance unduly escalating asset values.
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The end of irrational exuberance
By Michael Mackenzie and David Oakley
3 March 2009
The era of “irrational exuberance” is over, at least as far as equities are concerned. And after the falls of the past two days, investors must wonder just when the global bear market in equities will end.
In October 1996 the S&P 500 rose above 700 for the first time and by December of that year had gained 21 per cent. That prompted Alan Greenspan, the Federal Reserve chairman at the time, to talk of irrational exuberance unduly escalating asset values.
On Tuesday, the S&P finally fell back below 700 points. While the bear market of 2000 to 2002 shook investors and belatedly vindicated Mr. Greenspan, the subsequent years of easy money and financial excess proved beguiling. In October 2007, the S&P hit a record high of 1,565 points just as the financial crisis was beginning to take hold.
The S&P’s 55 per cent slide since then has been accompanied by drastic tumbles in other leading global benchmarks.
Financials remain the focal point of weakness. But the economic downturn is hitting an ever broader number of companies, forcing them to slash dividends, launch rights issues and preserve cash.
“The growing realisation that the economy is not going to turn around until 2010, at the earliest, is beginning to drive valuations lower across a broad spectrum of sectors and industries represented in the [S&P] 500 composite,” says Steven Ricchiuto, chief economist at Mizuho Securities.
This year, the S&P has dropped 23 per cent and the FTSE 100 in London nearly 21 per cent. In Europe the FTSE Eurofirst 300 has fallen 19.3 per cent, and on Tuesday hit a 12-year low. The Nikkei 225 in Japan is down 18.4 per cent.
Investor confidence in the global economy pulling out of its current slump is low, while the outcome of efforts by policymakers to reinvigorate it is uncertain. Disappointment with the early efforts of the Obama administration to tackle the crisis is one of the main reasons for the sell-off.
“The pronounced downturn in the economy has clearly exacerbated the problem facing policymakers, but the patchwork quilt of one-off initiatives and tailor-made bail-outs for the most stressed financial services companies has left investors with little if any confidence in either Treasury secretary [Tim] Geithner or Fed chairman [Ben] Bernanke,” says Mr. Ricchuito.
All the world’s leading stock markets have fallen sharply since Mr. Geithner unveiled his initial plans to tackle the financial crisis on February 10.
The FTSE 100 has fallen more than 15 per cent since then, and the FTSE Eurofirst is down 19 per cent.
Robert Parkes, UK equity strategist at HSBC, says: “The market was initially disappointed by Tim Geithner’s plans last month, and there is still a lack of detail on the stimulus packages coming out of the US, which is one of the reasons for the market weakness. The financial crisis is overshadowing everything, with confidence at a low.”
On Tuesday Mr. Bernanke said: “The recent near-term indicators show little sign of improvement.” He also observed that “significant stresses persist in many markets”.
Mohamed El-Erian, chief executive of Pimco, said on Tuesday the only way to stabilise the markets was for governments to produce much bolder, co-ordinated fiscal stimulus programmes.
“We need fiscal stimulus plans that address the problems of weak consumer demand and a weak financial system and housing market, and you need to do it in a globally co-ordinated way,” he said.
“We have seen some bold actions from governments, yet in the end they have been too little, too late. We need simultaneous moves that are big in size. The timing has to be right, which means now.”
Investors expect further bad economic news on Friday when the US February employment report is released. Job losses of about 700,000 are expected.
For some analysts the deteriorating US economy poses the biggest danger for bullish stock investors, who see value after such big declines in blue chips.
“One of the hallmarks of a post-bubble world is a greater degree of synchronisation between the economic cycle and the stock market,” says James Montier, strategist at Société Générale. “For investors in the aggregate market this means that one can afford to sit back and wait for the cyclical lead indicators to turn.”
It means that any rally in stocks may be no more than a bear market correction, warn analysts.
“We advise investors to take advantage of any market rebounds to sell or add to short positions,” says Charles Biderman, chief executive of TrimTabs Investment Research. “We believe the US economy is in the midst of its worst slump since the 1930s, and there is no bottom in sight.
“Our key macroeconomic and liquidity indicators suggest stock prices are going to fall a lot further than the conventional wisdom believes.”
Countering that view, Charles Dumas at Lombard Street Research suggests that the markets are unlikely to get much cheaper and that the upside is huge.
His research shows that US stocks are looking as undervalued as they did in 1982, prior to the bull market rally of the Reagan era.
UK equities are undervalued with “a positive yield gap for the first time since 1957-58, in favour of stocks against gilts”, says Mr. Dumas.
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