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Market commentary June 2008

By June 4, 2008No Comments

A fascinating month, and an encouraging one for those of us not inclined to hysteria in prior months.  Where it was assumed that the US was already in recession, now it is regarded as a 30% risk, and the OECD predicts it will not happen at all.  Most commodity prices have been slipping for a few weeks, and US oil demand has fallen, easing price pressures.  Nonetheless, it pays to be vigilant, and one way to try and remain level-headed is to consider the lessons of history.

There have been five major recessions since the First World War, not a huge sample, but it is nonetheless instructive to consider common causative features, and how these reflect on the current period.  These periods were 1920-21, 1929-32, 1973-75, 1979-82, and 1989-93.

The first occurred when a post-war boom was stopped abruptly (and deliberately) by Government spending being cut sharply, and interest rates spiking upwards. The fragile mood of the time rapidly moved from optimism to pessimism. The rest of the 1920s was marked by relatively slow growth and high interest rates, certainly compared to the US, and the stock market was steady at best, and not subject to a speculative boom such as occurred in the US. Nonetheless, the shock waves from the collapse of the US overwhelmed the UK (stock market and economy) from 1929.

The last three downturns are interesting for their similarities to today. The pivotal event in causing the 1970’s recessions was an oil price shock (it being a shock in the first instance due to war, and in the second because it followed the fall of the Shah of Iran). The 1973-75 downturn would never have been anything like as bad if controls on bank lending had not been removed in 1971, fuelling a speculative boom across all asset classes, and enabling heavy borrowing by industry.

The downturn from 1989, unlike the others, was not triggered by an external shock, simply rising interest rates. In the previous few years euphoria and over-optimism had become entrenched. The new competitive environment encouraged by Thatcherism had the unfortunate consequence of encouraging lending standards to relax, which prompted more borrowing, and even less prudent lending. The rise in UK personal and corporate debt in 1982-89 was faster than any other country. The UK populace (consumers, homebuyers, property developers, bankers, stockbrokers) was allowed to gorge, and it didn’t have the experience or commonsense to know when to stop. At least not until 1989 when, in the wake of interest rate increases (from 7.5% to 15%) there was a rapid collapse in confidence.

The element of shock (a random external event) laid on top of inherent vulnerability were key features (except in 1989). Though many will think that the “credit crunch” has played the role of the shock, it has done so unsuccessfully. There has been no cataclysmic collapse in confidence, though it has clearly tailed off. UK plc has been reducing debt in recent years. The banking system has wobbled, but some (such as the FT) have been as bold as to say this particular problem is now behind us. And the world is awash with cash (hence the bail-out of the US investment banks).

It is rising costs which will be the much more significant problem for quite a few years to come, and pressure on household budgets will trigger fundamental changes in spending habits. Not a major recession in the style of the above precedents, but an extended period of subdued growth.

Living in the UK will feel more uncomfortable, but as a UK-based investor the global opportunities are very encouraging.  As well as clear long term growth stories linked to stock markets, some other asset classes are already displaying outstanding value (such as corporate bonds).  The next TopFunds Guide will review these opportunities in detail.

Dennehy Wealth