Monday, December 29, 2008

A stock market recovery in the New Year?

The media is often accused of accentuating the negative, of spreading doom and gloom, but this is not actually true. In fact it tends to be over-optimistic about the economy and failed to foresee the 2008 Crash. And if you look at the range of predictions for 2009, you find many forecasters are expecting a dramatic recovery. The business magazine Forbes is not alone in foreseeing a 30% stock market rise in the next 12 months. Analysts from all the big banks like Morgan Stanley,JP Morgan, UBS and Citigroup have been quoted forecasting a substantial recovery in share prices of up to 50% in 2009.

You may wonder what planet they’re living on, when everyone can see with their own eyes that things are dire. The UK economy is expected to shrink by 3% in 2009, according to the British Chambers of Commerce, the steepest decline since 1946. The housing market is falling at its fastest rate in 25 years according to the Halifax. Unemployment is expected to increase by at least 600,000 in 2009 and most analysts believe there will be three million on the dole by the end of the year. Given unprecedented levels of consumer debt, collapsing corporate profits, continued problems for our insolvent banks and the threat of protectionism across the world, why would anyone seriously think things are getting better?

Well, history for one thing. Paradoxically, stock market recoveries often happen during the early stages of a recession, making it look as if capitalists are opening the champagne just as millions are being thrown out of work. Following the 1974 economic crisis the UK stock market roared in 1975, but that didn’t mean that the economy was in great shape - indeed the ‘recovery’ saw the Chancellor, Denis Healey, having to go ignominiously to the IMF for a financial rescue in 1976. Stock markets often bottom before the the economy because financiers have already “priced in” the economic recession and are speculating on the coming upturn. Since the stock-market collapsed by a third in 2008 - it’s worst year since the 1930s - many forecasters believe the bottom must have been reached.

This matters politically because it lends credence to the government’s claim that, by the second half of 2009, the UK economy will be out of the woods and on the way back to sustained economic growth. Except of course that won’t be - the “recovery”, if it happens, will essentially be a financial illusion. But it will at least allow Gordon Brown to announce that the ‘green shoots of economic recovery’ are poking through the permafrost. The media is only sensitive to stock market movements when shares go down. That’s when all the front pages show pictures of men in dealing rooms holding their heads in their hands or covering their eyes in apparent despair. In fact, they’re probably just thinking about where to go for lunch or trying to remember the date of their wife’s birthday, but the image is selected to fit the message. When stock markets go up these dealing room tableaux rarely feature and the economy is thought to be sound by default even if it isn’t.

House prices are the other touchstone index about which governments care intensely when prices fall. There is mild panic in the cabinet at the 19% crash in house prices over the last year and a half and the government will do almost anything to get prices to rise again. This isn’t rational because as many people gain from house price deflation as lose from it. Falling prices can also boost the stock market. With prices scheduled to fall by 50%, peak to trough by 2011, investors are going to be more likely to put their cash in shares than in property. Since the FTSE is seen as a barometer of economic health, this flight from property could help the government persuade voters that the economy is one the mend.

So, Gordon Brown is desperately hoping that the current rise in the FTSE will continue so that he can claim his policies are working. So, will it? Well, the trouble is that the stock market gurus all predicted exactly the same stock market rally this time last year. Yes, on the eve of the biggest crash in eighty years, there was hardly a banker in London who didn’t say that 2008 was going to be a great year for the markets. The vast majority of forecasters said that shares were cheap by historic standards, that the worst of the credit crunch was behind us, and that prompt action by the banks and governments would lead to a strong bounce in the markets throughout 2008. In reality, the FTSE fell by 31%.

How can so many intelligent people get it so wrong? This is one of the great mysteries of economic science: the complete unreliability of forecasts. Surely anyone with eyes could see, twelve months ago, that there was too much debt in the economy, that the housing market was collapsing, that banks had lent far too much money, and that the so-called shadow banking system of hedge funds and derivatives, was in deep, deep trouble. Northern Rock had been nationalised in September 2007, after all, and banks had stopped lending to each other. So why did no one realise that this would bankrupt the banks? Taking their lead from the Bank of England, which insisted through the first half of 2008 that Britain was going to avoid recession, that house prices would stabilise not fall and that the banking system was quite safe, the wise heads of the finance houses all confidently forecast that things were going to be fine. They weren’t.

This fantasy forecasting is a serious problem. The entire forecasting industry and the media in general is massively over-optimistic. It always says shares are going to rise. It is a kind of collective delusion brought about by an ideological blindness to the dynamics of the capitalist system. In the boom years there was huge pressure on individuals not to depart from the consensus that the economy was robust and that house prices were not going to fall. Anyone who said anything different was likely to be accused of “talking the market down”, being a “perma-bear” or simply a crank. Professor Nouriel Roubini for example the New York economists who correctly forecast the collapse as early as 2006, and was labeled “Dr Doom”. Even now, mainstream economists say Roubini was right for the wrong reasons, and that ‘even a stopped clock is right twice a day’. Well, they said it: a broken clock is a better economic forecaster than the cream of City financial experts. Perhaps you should bear that in mind before you put your money on the boom of 2009.

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