Bears gather for second rampage

By Neville Bennett

Friday 21st May 2004

The old adage of "sell in May and go away" seems singularly apt this year. A fierce downturn in equity markets has afflicted most global markets since April and has destroyed much wealth.

Is this a temporary blip? Or is it a revival of the bear market that dealt enormous destruction in 2000?

It's been suggested the strong bull market is an aberration, that it has hindered the inevitable readjustment in the fundamentals of the market by preventing a necessary correction.

There are plenty of analysts and chartists who are now saying the surge in markets since last year was a "dead cat bounce."

The Euro top 300 Index, which tracks Euroland's top stocks, has lost all its gains this year, including an 8% fall in the last couple of weeks. Spokesmen cite negative sentiment arising from Iraq, high oil prices, fear of a hard landing in China, high unemployment and slow European growth as the reasons for jitters. Obviously, many investors are insecure, wondering if equities are a better option than more conservative investments.

Some pessimism arises from a burgeoning belief earnings will be under pressure and growth more hesitant in a world of higher oil prices. Nevertheless, it must be said the Euro stocks do not appear to be significantly overpriced, as price-earnings ratios are a healthy 12.5.

The pessimistic mood in Europe is hard to comprehend from this distance.

While acknowledging real problems in aligning budgets with revenues, it is hard to understand why so many Europeans stress the loss of export opportunities and so few remark on the lower import bill that is the reverse side of the coin.

Wall Street is depressed in sentiment. It is particularly concerned with the specific of certain interest rate rises, the threat of inflation, the morass in Iraq and the uncertainty of this year's presidential election.

It is fair to acknowledge, too, that risks have increased greatly since the New Year. The gradual fall of the equity market and the rise of longer-term interest rates has subtly changed the atmosphere.

Gone is a ubiquitous expectation of an ever-strengthening equity market. It has been replaced by nervousness, even an apprehension, of a persistent bear market.

But some strong positives remain, even if they are overlooked. Economic growth is high and profitability excellent. The Bush administration is using every lever to prime the pump for the election, with easy credit, some tax cuts and a babble of optimistic prediction.

It could be whistling in the wind. At the start of the year, most were convinced the bear market was dead. Now, many are not so sure.

Perhaps the Fed's indication that interest rates are going to rise has taken its toll. But more depression has resulted from the butcher's bill in Iraq and the huge surge in oil prices.

Americans have been feeling good for some time, boosted by appreciating house prices and cheap credit. But record prices for petrol are baffling and seem to be a brutal assault on consumer freedom.

Americans have been brought up to expect cheap petrol. Present prices seem to menace the American dream.

But investing in equity and funds is familiar to more than 50 million Americans. They have been told such investment is the sure way to wealth. There is an expectation of methodical progress; only a minority realises markets are more cyclical than linear. Experts realise bear markets can be persuasive.

An excellent warning was sounded by Maggie Maher (Financial Times, April 11), predicting a "very long bear market." It will be noted the article appeared before the recent steep decline in prices.

The article is based on the explicit assumption that a market cannot advance confidently until there has been a healthy correction. It is assumed the correction will take the market down to its mean price.

This means, in practice, the S&P500 ought to revert to its long-term mean p/e of 17 and dividends of 4%. At present, the S&P 500 seems overpriced with p/es of 29 and dividends of 2%.

Once investors begin to think the market is over-priced, other factors begin to be acknowledged a record current account deficit, a huge fiscal deficit, a mountain of consumer debt, a weak dollar, sluggish capital investment and sticky real wages. These could be shrugged off as self-righting in an ebullient market but not in a downturn.

Mahar postulates it takes at least two great selloffs to break the hearts of bull investors. They endure one great loss, the second one is final and they leave the market for 10 years.

Two selloffs are quite usual in downturns. In 1929, for example, there was a bust but plenty of bull persisted. The market made a recovery, gaining 50%, but there was an extended downturn through 1930-32. When it was over, the market was down 86%.

Mahar also offers the example of the 1970s. The market rose through the 1960s, but early on the Dow Jones crashed from 1000 to 631. Some investors were undeterred and the Dow Jones peaked at 1071 in 1973. The crash of 1973-1974 then began. When it bottomed out the Dow Jones was 577 still below its 1958 tidemark.

Could the Dow crash in 2004? Mahar thinks it possible. Certainly, the chart has an ominous shape and a suspension of the bull market is possible.

There could be an extended period of sideways trading, with some sectors faltering and others making a small advance. A bear rising from hibernation is possible but not a certainty.

Wealthy investors could lessen their risks by pausing in their acquisition of equities and devote a higher allocation to gold, fixed interest and hedge funds.

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