What Will 2009 Bring?

Posted on: 06 January 2009 by Gareth Hargreaves

Graham Kerner gives his view on the prospects for the markets in 2009.

The UK stock market was in defiant mood last week, shrugging off a plethora of poor economic news, preferring to look forward to a better year in 2009.

A last minute rally, albeit on the back of low trading volumes, saw London’s blue-chip index surge 8% on the week. But there was no denying that 2008 will go down as the FTSE100’s annus horribilis – the market ended the year down some 31%. As The Times commented, collapsing banks, stumbling mining giants and innumerable retailers heading into administration - triggered by the sub-prime crisis in the US - has taken its toll across almost every sector.

Not that the slump in share prices was peculiar to London of course, the pain was shared globally across developed and emerging markets alike. Wall Street and Europe fell almost 40%, Tokyo 42% and the once high flying markets in China, India and Russia plummeted anything up to 72% as investors fled for the safer havens of government bonds and cash.

The mini-rally that kicked off last week may appear surprising to the casual market observer given that the economic news emanating from the US and replicated in the UK, was unremittingly awful. The Daily Telegraph commented that the manufacturing sector is trapped in the worst slump since the early 1990s and continues to shrink fast, according to figures released by the Chartered Institute of Purchasing and Supply (CIPS). The CIPS index measures the activity of around 700 manufacturing groups and is currently at 34.9 – any number below 50 signals contraction.

It’s a similar story in America where the factory index of the Institute for Supply Management hit 32.4, falling at its fastest rate in 28 years. For good measure, The Financial Times reported that it was a similar story in the eurozone where the region’s equivalent of CIPS was unexpectedly revised downwards to a new low. The gloomy news failed to dent investors’ spirits though, fuelled by expectations of lower interest rates.

Against the backdrop of what is clearly a severe economic downturn – data technically confirming that the West is in recession won’t be available until later in the month – industry is understandably calling for lower borrowing costs. The Sunday Times reported comments from the British Chambers of Commerce saying “The rapid worsening in the economic situation and growing fears over rising unemployment reinforce the need for the MPC to continue with aggressive interest-rate cuts”.

The Bank of England’s (BoE) Monetary Policy Committee is due to meet this week and the markets have priced-in a rate cut of 0.5%, although a number of analysts would not be surprised if the Bank went for a full percentage point cut. A half-point cut would take the base rate down to 1.5%, the lowest in the Bank’s history and last witnessed in 1694 when William III was on the throne.

One side-effect of cheaper borrowing is pressure on sterling – the currency fell almost 25% against the US$ last year and is perilously close to parity with the euro. Lower rates are likely to exacerbate the situation, but the winners are UK exporters who are clear beneficiaries of this policy.

Cheap Money

The BoE’s monetary policy may well be creating cheaper borrowing but the thorny question seems to be “do people want it?” The Times reported that there is further evidence that householders have cut retail spending and started to reduce debt.

Data from the BoE showed that property owners paid a record £5.7bn off their mortgages in the three months to September – the largest figure since the 1970s – twice the amount in the previous quarter. The paper said the change underscores the end of a decade-long borrowing binge driven by soaring property prices.

However, the UK government is hoping that lower borrower costs will actually stimulate more borrowing this year, although all the indications are that banks are planning further cuts in lending. The Financial Times noted that a survey by the BoE suggests that, in spite of the £50bn recapitalisation of the financial sector by the government and record cuts in interest rates, banks are looking to tighten up on lending even more during 2009.

The paper said this will come as a blow to ministers and the Bank, who are increasingly concerned about the parlous state of non-financial businesses which are facing a credit crunch.

On the other side of the Atlantic it appears to be a similar story with ultra-low interest rates not working in the way the Federal Reserve hoped. Consumer confidence plunged to its lowest level since 1967 as Americans worried they might soon join the 240,000 people a month losing their jobs.

The situation has been compounded by the seemingly remorseless fall in US house prices. According to the S&P Case-Schiller index – widely seen as the most authoritative measure of property values – house prices fell 18% in October compared to a year previously, with the worst drop in Phoenix, Arizona where prices fell almost a third. But even though householders are reaping the benefits of lower oil prices and mortgage costs, they are not being tempted into spending more in shopping malls or buying big ticket items such as cars.

The plight of Detroit’s ‘big three’ carmakers led to a bail-out of the industry by the Bush Administration last month and hopes are riding high that the Fed’s recent decision to lend $6bn to GMAC - the finance arm of General Motors - could be enough to halt the slump in sales. GM is now offering no-deposit, interest-free car loans plus price discounts to lure customers into the showrooms.

Hope Ahead

Whilst the inevitable effects of a global economic slowdown are creating huge pain for many, there are genuine reasons for being more optimistic about the longer term.

Economist David Smith writing in The Sunday Times argued that, despite the failure of the banks to lend prudently in the past and now aggravating the situation by not lending at all following their near-death experience last year, the government’s economic stimulus will help.

He pointed out that unlike the eurozone, rate cuts have not been offset by a rising currency plus there has been a real income boost from lower energy prices, cheaper borrowing and consumer borrowing is, after all, financed from income growth.

Smith drew a parallel with the 1930s when Britain had a single, very bad year before embarking on a long upturn thanks to the stimulus largely brought about by leaving the gold standard. True, growth will remain weak this year he said, but the balance of payments could end up in surplus as exporters take up the slack. Clearly though patience is needed in the meantime.

Star Gazing

It’s the time of year when investment experts are asked to gaze into the crystal ball and make predictions about at what level they see the stock market ending the year. It seems that the consensus is for the UK stock market FTSE100 index to end the year around 5000 although the predicted range is large: anywhere from 3700 to 5555, according to the experts.

So what should investors expect for 2009? Retired investment manager Anthony Bolton of Fidelity – renowned for his excellent stock picking abilities - shared his thoughts with The Financial Times and started by advising investors first not to try and time the market.

Most investors have a positive or negative bias which makes them good at buying but not selling and vice versa: this can cloud judgement. If you miss even a few of the best days of a bull market, returns will be diminished and some of these days occur at the start of a new bull trend.

Bolton said that a bull market tends to climb a wall of worry and because the stock market is an excellent discounter of the future it usually moves on what investors expect to happen in six to twelve months time.

So, if you wait for the good news you miss out on the rally in prices. Drawing on his past experience he said that using measures of sentiment, historical patterns and long-term valuations he felt optimistic that 2009 will be a better year for equities.

His views are echoed by the likes of Warren Buffet, known as the Sage of Omaha, who says he’s been buying US stocks because they are good value.

Time To Review

Now is always a good time to sit down and review one’s portfolio and more importantly the strategy that drives decision making. The Sunday Telegraph shared some thoughts with its readers about what course of action they might consider for 2009.

The starting point for any private investor is to decide whether to position a portfolio to try to “shoot the lights out” by taking big bets on certain asset classes (including the geography) or position it to achieve less volatile returns.

The paper said that last year, even a diversified portfolio would have fallen in value but this is not a reason to abandon such a strategy. Ideally, investors should hold a spread of investments that have the potential to perform well but do not all fall at the same time so it makes sense to own cash, shares, government stock, corporate bonds and commercial property. Better still, spread the strategy across a number of good investment managers with different styles – this will further reduce the risk.

So at the beginning of 2009 investors are faced with the following scenario: interest rates have plunged and set to go even lower and many deposit accounts produce zero or even negative returns after allowing for tax and inflation – this point was well made by the weekend press. So whilst we all need some cash it is becoming less attractive.

Gilts did well last year as investors sought safer havens and if interest rates continue to fall this year then it continues to create a positive backdrop. Corporate bonds fell in value last year because of the problems in the credit markets but income yields are now very high - anything up to 12% gross - and spreads - when measured against gilts - are narrowing, albeit slowly, as confidence returns, meaning capital gains.

Commercial property values fell last year but income yields have risen as a consequence and historically as an asset class it has done better than cash and fixed-interest. Shares fell last year but again yields have risen – the UK market yields around 4.6% (net of basic tax liability) – and at these levels has already priced - in a huge amount of bad news (Anthony Bolton’s Wall of Worry).

It’s a similar story for overseas equities too, where price falls have created long-term opportunities. The paper concluded that, although most investors will have lost money last year, a diversified portfolio will have cushioned this and remains a good strategy for the future.

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