Recovery? What Recovery?

published 31 October 2005

The worldwide bull run has just celebrated its first birthday, says Deborah Hargreaves in the FT. Growing confidence in the US recovery has boosted the FTSE World index by 36% from its bear market nadir of October 2002, America's S&P 500 index has since gained 30%, while the tech-heavy Nasdaq index has soared by 70% to a 19-month high. European stocks, which bottomed in March, have also risen strongly, with Britain's FTSE 100 up 31%, now at a 13-month high. British investors' confidence in the sustainability of the rally should be bolstered by a 15.6% surge in the average dividend payout during the third quarter, reflecting accelerating corporate earnings, says Gary Duncan in The Times. Year-on-year dividend rises reached just 5% and 7% in the first and second quarters respectively. The fillip to UK exporters to the eurozone provided by the pound's weakness against the euro, along with the return of "some real corporate activity" and "attractive" valuations of UK blue-chips, also bode well, says Hargreaves. Baring geopolitical shocks and a sudden collapse in house prices, an enduring US recovery could propel the FTSE to just under 5,000 by the end of next year, said Bill Jamieson in The Scotsman.

What recovery? asks www.Dailyreckoning.com. Not only have GDP figures been artificially inflated by "crunching numbers into such grotesque shapes that even their own mothers wouldn't recognise them", but September's rise in employment also looks "a little troubling": the Government "revised away" 145,000 jobs from the prior 12 months just as it added 57,000 new ones. Meanwhile, although the short-term earnings outlook has improved, US companies' long-run growth prospects are "poor", says Investors Chronicle. Earnings growth depends on the proportion of profits a firm ploughs back into its business and the return on capital earned by that investment. In the second quarter, companies retained only 63% of their profits, and their return on capital was a mere 3.8%. This kind of low return should prompt firms to shrink their capital stock by scrapping capacity, thus engendering higher long-term growth. But the current buoyant levels of debt imply that capital stock remains high. We also have the highest valuations since 2000, which bodes ill, says Dailyreckoning.com: the Nasdaq 100 trades on eight times sales - a level at which you can only get your money back by "selling to an even greater fool".

Indeed, says Adam Hamilton on www.Zealllc.com. The market's p/e has yetto fall to the single-digit levels that for centuries have marked the end of a long-term downswing. So this rally is just a cyclical bull market within a secular bear trend. These are not uncommon - witness the 18 month, 59% rebound during the Japanese bear market - but, "sooner or later", the Great Bear will reassert itself.