Three days after Lehman Brothers collapsed in mid-September, stock markets were in freefall.
By Chris Hughes, breakingviews.com
Last Updated: 6:33AM GMT 09 Jan 2009
The world looked so gloomy that some equity investors hailed the week as the so-called "capitulation event" - the painful point of maximum bearishness that clearly establishes the trough of the market. The announcement of the US Troubled Asset Relief Programme arrested the selling.
But by late November, the MSCI World Index and S&P500 had fallen another 35pc. Equities had fallen 54pc from their October 2007 high, before the worst of the crisis hit.
Equity investors never know when they are at the bottom. But if the market rout prompted by Lehman was a false floor, the rally since late November is proving resilient. As of January 8, the World Index was up 22pc from last year's low, touched only seven weeks earlier. The question facing equity investors is whether this is just another bear-market rally, and, if not, how quickly markets will continue to recover.
Bear markets usually last longer than two years. But the latest downturn has been particularly accelerated. And there are multiple arguments why equities have now found their floor.
While higher current dividend yields partly reflect the risk of imminent dividend cuts, the equity yields still look good compared to government bonds and cash, whose yields have plummeted. Cash has never looked so expensive. The equity risk premium is at its highest in a decade, according to Morgan Stanley. Furthermore, corporate insiders, who should know something, are buying at record levels.
Analysts expect the recession to cut corporate earnings in half, including a 10pc decline in 2008. But equities appear to have fallen enough to reflect that savage drop. Global equities have not been so cheap on either spot or trough earnings for over two decades, says Citigroup. They are trading on a historic price-earnings ratio of around 11 times. Credit Suisse says historic consensus earnings multiples were an average 15 in the last four market lows.
Stock market history suggests that equity markets recover before bad news from corporations has stopped and while earnings are still falling. Equities can bottom out as early as five quarters before earnings trough, and do so on average after two quarters.
But to be buying now, equity investors need to satisfy themselves of two things.
- First, that earnings will indeed trough this year.
- And second, that this time will not be different, even in the face of a global deleveraging of unprecedented intensity.
The massive government stimulus packages that investors hope will underpin recovery carry risks of their own, in particular if weak currencies create an inflationary squeeze on corporate profits. The financial pummeling could slow the pace of any stock market recovery, even if profits are recovering. There must also be doubts about the new normal price-to-earnings ratio is a de-levered world.
And these uncertainties should be sufficient to keep equities cheap for a while yet.
For more agenda-setting financial analysis, visit www.breakingviews.com
http://www.telegraph.co.uk/finance/markets/4205812/Shares-are-cheap-but-its-not-the-time-to-buy.html
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Investing in time of uncertainties
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