SUMMARY. Risk appetites have returned, stock markets around the globe are recovering strongly. But what is driving this bounce? And is it sustainable?
In a conversation with the FT in December 2008, we said (only half jokingly) that it was possible to cogently argue that by the end of 2009 the FTSE 100 index could be at either 2000 or 6500. We suggested that as life’s experience is often that the truth is somewhere in the middle, perhaps 4250 by end-2009? Now as we write the index is toying with 4500. Since March, risk appetites have returned, and stock markets around the globe are sharply higher, and we need to explore the sustainability of this rise.
If the vast sums on deposit around the world are switched in earnest into risk assets, markets will go much higher than we have already seen, and the new bull market will have begun. A concern about the recent rises is that leadership has come from the likes of the beaten-up banks and smaller companies (since the beginning of March the FTSE Small Cap index is up a huge 34%, compared to the footsie up just 11%) and therefore this rally might not have a solid foundation.
History suggests that a sustainable rally, and the new bull market, should be led by the largest and most liquid quoted companies, which institutions sitting on cash piles will find easiest to buy. In contrast smaller companies are not as easy to buy in volume, and it is volume buying that is needed to sustain a bull market.
As for the banks being bought, it is hugely encouraging that we have moved away from the risk of the global banking system closing down, but banks still do not have enough capital. And if we are following the Japanese model (allowing the banks to slowly replenish their coffers via profits in coming years), it suggests a slow recovery for banks and the economy at large.
We don’t want to be slaves to historical precedents, because there are so few precedents, and because there is a risk that, as human nature continually drives us to try and identify patterns, we are distracted from spotting important differences e.g. in this downturn the speed with which massive stimulus was applied to the global economy. But we must not ignore what is right in front of us.
So how can recent market moves be explained? It wasn’t just “risky” bank shares and smaller companies that were being purchased. If the phrase “junk bonds” could ever be fairly applied it would be to those right at the bottom of the pile, what are called CCC-rated – even in the good times 40% of these go bust. These also joined in the party.
The most obvious reason behind all of this was that in the Autumn the riskier asset classes fell off a cliff, and were priced for Great Depression II, or Armageddon, or whatever you wish to call it. If the growing number of “green shoots” tell us anything, it is that Armageddon is not upon us, just a severe recession. That being the case there has been a re-pricing of the riskiest assets, and a new floor has been established.
There is much about which to be encouraged in recent months, but a sustainable recovery in stock markets requires evidence of volume buying of the largest blue chip companies. We aren’t there yet, and thoughts of 6500 in 2009 are fanciful (but we can dream, and, to badly paraphrase the closing credits of Gone With The Wind, “2010 is another year”).
P.S. no doubt many of you have been tittering about Swine flu, in particular the media coverage. Yes, a serious problem for an unfortunate number, and one day it appears a certainty that a pandemic will sweep the globe. But the day the story broke in the media one newspaper stretched credulity as the story seamlessly swung from “Two honeymooners hospitalised in Scotland” to “120 million people to die globally”.
