This is no time to buy stocks

published 31 October 2005

"The good times are rolling again," says James Bartholomew in The Daily Telegraph. The new bull market that began in March has lifted the FTSE 100 index by about 34% - some smaller companies have appreciated by more than 50% - and "I expect it to continue". Note that a host of pundits "with impressive track records" remain sceptical, citing the uncertain economic outlook and high levels of debt in the US and UK. Indeed, despite the strong gains, many people seem loath to use the term bull market', lest it "disappear in a puff of smoke". This is "classic bull-market psychology". New bull markets "climb a wall of fear"; the doubts, therefore, imply further gains.

Not so fast, says Richard Wachman in The Observer. The problems highlighted by the sceptics could derail the rally. Last week's results from Debenhams and Burberry, where like-for-like sales climbed by just 3.7% and 2% respectively, provide further evidence that recent earnings gains have been achieved only via cost-cutting. Meanwhile, consumption is vulnerable to a rise in interest rates as growth picks up, since Britons are deeply in debt. Higher rates could also cause a crash in the housing market. On the plus side, UK stocks remain more attractively valued than US and many other Western equities, says Stephen Foley inThe Independent, and local fund managers are more optimistic about Britain's economic prospects than their US counterparts are about America's.But "none of this has previously enabled UK stocks to decouple" from Wall Street, so any setbacks there will "almost certainly" be mirrored here. One worry currently dogging US stocks is that the weakening dollar will prompt foreign investors to reduce their large holdings of government bonds, thus pushing up yields, making corporate borrowing more expensive, and choking off the investment needed to sustain recovery. The dollar's drop since August has impoverished foreign central banks, which hold $1trn of US debt, by about $85bn, says www.DailyReckoning.com. "That's real money".

"Another warning flag" is the market's muted response to last week's strong earnings reports by General Motors, IBM and Merrill Lynch, says Mark M Rostenko in the Sovereign Strategist: the latter two actually finished the week in the red. This suggests that the market had priced in the strong third-quarter earnings recovery, and now that it is being confirmed, there is nothing left to propel it to new highs. Especially since current prices - the Dow Jones is on a p/e of 22, not far off its bubble peak of 26 - imply that these high earnings "will be maintained indefinitely", says Andrew Neil in The Business. Yet "this Indian summer of profits" is likely to prove "as good as it gets"; as growth picks up, streamlined companies should increase capital expenditure and hiring, thus reducing net income. "This is no time for diving into stocks."