FTSE needs to fall 40% in 2004

published 31 October 2005

After a spectacular run in 2003 things have taken a turn for the worse for Western markets in 2004, says FT.com. The FTSE has fallen 2% this year, and the Nasdaq and Dow, after a few volatile weeks, are hovering around the levels at which they started the year. These are undoubtedly uncomfortable times for markets. Indeed, says Tim Price of Ansbacher Wealth on Bloomberg.com. It looks like just about every "investment target" is going to blow up. Which you think will go first is just "down to personal choice". If you follow Sir John Templeton, it's the housing market; if you follow Jim Rogers, it's the US dollar; if you follow George Soros, it's the bond market; if Bill Gross, it's the economy as a whole; and finally, if you listen to Warren Buffet, it is stocks, bonds and the dollar. Anyone who isn't with these proven gurus and follows instead the likes of Ken Fisher, who believes "US stocks are attractive on a relative valuation basis", is "probably an idiot".

Too right, says Philip Coggan in the FT. In the US, valuations are still much too high in historical terms. "This is true whether one looks at p/e ratios, asset values or dividend yields." Many may argue, as Fisher does, that it relative valuations that really count, and that these now make shares a buy compared to bonds and cash. But historically this has not been the case. And it isn't now, says Edmond Warner in The Guardian. You can't get away from the fact that recoveries from previous post-bubble collapses "have been marked by valuations falling to bargain-basement levels". That will have to happen again to allow for a real recovery. So how far should the FTSE fall to satisfy this condition? At least 40%, arch bear Andrew Smithers told The Sunday Telegraph. "Equities represent a title to the ownership of real assets" so "they should have a market value equal to the cost of their production". Do the numbers, and that suggests that the FTSE 100 should be trading at around 3,084 today.

The implication of high valuation levels, says Coggan, is that "investors are expecting good news in terms of profit or dividend growth". And right now, both terrorism and slowing economic growth are making that increasingly unlikely. There are clear signs of a loss of momentum at both the market and macroeconomic level, says Lex, also in the FT. Indicators such as the Institute of Supply Management index are peaking and the "stubbornly high" oil price is keeping a lid on US activity. So expect the market to keep falling, says Anais Faraj, equity strategist at Nomura. In 2003 global markets were "driven by liquidity and low interest rates". Today, with the exception of the liquid Japanese market, it is moving towards trading on "fundamentals". The debate should now be less about whether the market will fall and more about how far that fall will go.