A 'sickening plunge' ahead?

Major stockmarkets "hit turbulence in a big way" last week, says Michael Morgan in the FT. Tokyo plunged by more than 5% and Hong Kong lost 4% on Thursday. These declines, the worst since 12 September 2001, were triggered by disappointing corporate results on Wall Street and exacerbated by profit-takers. Britain's FTSE 100 fell by 2.6% in just two days, as Wall Street faltered and the prospect of impending interest-rate rises raised the spectre of a fall in lending, consumption and house prices. Global jitters subsided later in the week, with America's S&P 500 index finishing 1% down.

The trouble with this US earnings season is that although many companies are beating expectations, the market is "priced for perfection", says E S Browning in The Wall Street Journal. With the S&P 500 at 29 times earnings, hopes are so high that "anything short of a breathtaking earnings report" disappoints - witness Microsoft's 8% slide following its forecast-beating profits performance, as investors seized on some evidence of weak sales to corporate customers. The market has finally noticed that strong third-quarter profits have been due largely to cost-cutting, not any pick-up in sales, says Alan Abelson in Barron's. And even now, sales rises look unlikely, since the third quarter's high GDP growth, far from heralding recovery, is a "blip". The economy has been "on steroids dished out by Uncle Sam": hefty tax cuts and cheap credit have all encouraged yet more spending. But the tax cuts have been spent and the "vast explosion" of mortgage refinancing is over. Even more ominously, bank lending has been shrinking and growth in M3, a broad measure of money supply, has fallen at the fastest pace in a decade.

Slowing commercial lending and a recent contraction in overall money supply has prompted analyst Michael Belkin, who correctly forecast the Nasdaq's "boom, bust and re-boom", to predict both the end of the liquidity driven rally and a "swan dive" for all major developed markets during the fourth quarter, says TheStreet.com. And he doesn't see much of a recovery for 2004 either. He's not the only investment expert with a proven track record steering clear, says Allister Heath in The Business. Warren Buffett said last week that he is sitting on his $24bn cash pile because he can't find any bargains in the over-valued US market.

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Small wonder, says Mark M Rostenko in The Sovereign Strategist. The S&P's valuation is "something you'd expect to see at a major bull-market high". So is extreme bullish sentiment: all four major sentiment gauges are above the 57% bullish level for the first time. Throw in the fact that insiders have been "selling in droves" and the rally looks very shaky.