SUMMARY. Action to nationalise the two US mortgage giants was another encouraging initiative by US authorities to shore up financial markets. But the global economic downturn triggered by the inflation shock this year (not the credit crisis that began last year) could yet push the UK stock market lower – at which levels there will be very rare buying opportunities, if history is a guide.
How dare he? The announcement by Chancellor Alistair Darling (“The UK is facing its worst economic crisis in 60 years”) prompted a torrent of editorials from the (largely Tory?) press that there is nothing much wrong with the UK economy. It’s OK for the press to kick the UK economy as it heads south, but the Chancellor should keep his thoughts to himself. Remarkable hypocrisy from the UK media.
It might have been a cock-up on the part of Darling. Or it might have been advance special pleading, ahead of a pre-Budget report that is likely to drive a coach and horses through his predecessor’s Golden Rule (which requires that the Government balances its books over the economic cycle). From an economic perspective, the Government will surely need to announce a range of substantive initiatives to take the sting out of the downturn. From a political perspective, if the Government doesn’t show that it can act decisively in the months ahead, their odds of success at a General Election (which must be held by Spring 2010) are less than slim.
As an early initiative the recently announced package, to boost the housing market, was not a good start. For example, increasing the stamp duty threshold to £175,000 seems likely to drive down house prices just above the threshold, resulting in even more negative equity.
In stark contrast the US authorities have again shown strong leadership in moving to nationalise the huge mortgage institutions, Fannie Mae and Freddie Mac, attempting to head off one or both failing, which would have triggered huge volatility in markets, threatening the whole US economy and many beyond their shores. Global stock markets immediately responded with sharp recoveries.
Yet this action, as with the Bear Stearns rescue, is to limit fallout in markets from the credit crisis that unfolded from Summer 2007, and will have little or no direct impact on the wider economic downturn, in the US and beyond, which was triggered by the inflation shock in 2008.
That is why, if we now turn our attention to the UK stock market, the range of 4500-4800 for the FTSE 100 index (currently 5400) could yet prove to be irresistible, as the economic slowdown comes more into focus in coming months. At those levels the UK market would be a compelling “buy” for many institutions, sitting on huge volumes of cash, as dividend yields would be heading quickly to 5%, compared to gilt yields no higher than 4.5%. In March 2003 a similar signal would have got you back into the stock market almost exactly at the bottom.
Such signals are rare, and the last time that equity dividends were consistently in excess of gilt yields was in the 1950s. This compelling indicator might be just what is required to lay down the strongest possible foundation for a long term stock market recovery.