Crash! Panic! Doom!

22/01/2016 at 6:26 pm

So this week London entered a bear market. Some commentators discern echoes of the “2008 financial crash”. Sage market participants – who have been warning us about China* / Emerging Markets* / the Euro* / QE* / Commodities* / Debt* / Deflation* / Monetary Tightening* [*delete as appropriate] – for several years have finally been proved right. Several of them caution, sagely, that we should remain cautious as it could have further to go.

Yes, this week, the FTSE 100 Index entered a “bear market”, as defined by a fall in value from its closing peak (7,103.98 on 27 April 2015) of at least 20% – 20.14%, to be precise, reached on Wednesday with a closing price of 5,673.58. It should be obvious that this signifies nothing whatsoever more than a fall of 18% or 19% but there we are. Markets have their conventions. This is now, technically, a “crash” rather than a “correction” (a fall of between ten and twenty percent). And some would have us believe it’s 1929 all over again.

Such, however, it cannot be. Global equity (as measured by the MSCI World Index) has not entered a bear market – it has fallen by 17.62% from its peak – and this is entirely due to Wall Street. The S&P 500 has shed a mere 12.74% from its heady peak last May. Since the US market makes up a little under 60% of the developed world’s total market cap this more than makes up for the fact that Tokyo and … erm … Brussels? … have entered bear markets alongside London with the TOPIX and Euro Stoxx 50 indices down 23% and 25% respectively.

Even here in the UK the crash is not that clear cut. The mid cap FTSE 250 Index has shed only 14%, with the small cap index having done slightly better. Considering the fundamentals this is understandable. There are few oil supermajors bestriding this particular corner of the marketplace, or mineral colossi. The much vaunted overseas exposure of the large cap index has been, at best, an equivocal strength with the UK economy doing as well as it has (not to mention the distorting effects of all that foreign exchange exposure). So the current infestation of bears has been locally as well as globally selective.

Still, who needs “fundamentals” with all that lovely panic to go around! Surely it can only be a matter of time before those other columns tumble? After all, it’s 2008 all over again!

Except, of course – it isn’t. Not even remotely so. Back in 2007, to refresh our memories, there was a massive over-extension of credit via packaged structures that were as poorly valued and understood as they were widely held. A few mortgage arrears in the US later and the world’s financial system suffered cumulative capital losses just shy of $2trn and would have collapsed without the $1.5trn of capital that then had to be pumped into it, mostly by governments. Then in the autumn of 2011 it looked as though the bond market might close to Italy. Since the Italian economy is rather large, with a commensurate burden of sovereign debt, it was certain that neither the IMF nor its sponsoring governments would have been able to afford a bailout. At that point we could have seen governments across the developed world plunged into default.

Now that would have been a disaster.

And what is behind the doomsaying today? The rate of GDP growth in China down by 0.1%! Oil falling – which is admittedly more dramatic – but unlike the financial crisis will prove an economic benefit on average (and perhaps delay the need for monetary tightening in Britain and elsewhere). Or perhaps it is simply the case that the bull market run since 2009 got ahead of itself and equities are anticipating the forthcoming change of cycle.

On that last point there is something further to be said about all those crashes and corrections. Amid the justifiable fear of 2011 the S&P 500 had a peak-to-trough fall of 19.4%. Admittedly, this is a whole 0.6% short of a full-blown bear market, or “official” crash. But it was not much fun for investors at the time. And away from the US, stock markets have had a much more equivocal rally. While the S&P raced ahead during 2013 and 2014 for instance, returning 50% over those two years, the FTSE 100 returned only 20%. In Japan, suffering from the earthquake and tsunami of 2011 and their aftermath, the market did not even start to climb until the tail end of 2012. The years since the credit crunch and Great Recession have seen healthy equity market returns – at times, in some places, and in fits and starts. But it has not been any sort of eye-watering, valuation-busting rocket trip.

We are where we are. But the crash has been as partial as the bull run, the panic is hard to justify – in some respects, even, absurd – and it may yet prove that all the doomsaying is being listened to just a little too closely.


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