The shocks just keep coming, as the market continues to tumble and shares continue to get cheaper and cheaper. If it wasn’t happening in front of your very eyes, you’d never believe it.
1. Base interest rates at 1%
The Bank of England recently slashed its base rate to 1%, the lowest level in its 314-year history. It's even lower than the 2% it was at in 1951, when Winston Churchill was in power, and the country was recovering from its massive war effort.
The battle of 2009 is The Great Credit War or The First World Recession. Individuals and businesses have too much debt. Banks are not willing to lend, for fear of exposing themselves to yet more bad debts. People are not spending, instead they are hoarding whatever spare cash they have. (Ed: It’s called saving, stupid, an ancient pastime last seen in the early 1980s!)
House prices continue to fall, plunging an annualised 16.6% in the year to January. With unemployment on the rise, banks unwilling to lend, and potential buyers waiting for prices to get even cheaper still, the outlook for house prices is not promising.
But think ahead. Think ahead to the days when the economy gets back to some level of normality. Believe it or not, it will happen, probably in 2010. Think about mortgage rates of 3.5%. Think about how attractive the dividend yields on shares are compared to savings rates.
Some economists are forecasting the cost of borrowing could fall still further, with a base rate of 0% no longer out of the question. It's there in the US, and if it can happen there, it can happen here too. I never thought I'd see it.
2. FTSE 100 Shares trading on P/Es of less than 5 and dividend yields of more than 10%
I remember people who were actively investing during the 1973-74 stock market crash telling me that back then, banks traded on price to earnings ratios (P/E) of 2, 3 and 4. I found it hard to believe, and thought it could never happen again in my investing lifetime.
Fast forward to today…
Company | Share Price | Trailing P/E |
|---|
| Barclays (LSE: BARC) | 105p | 1 |
| Lloyds Banking Group (LSE: LLOY) | 57p | 1 |
| Royal Bank of Scotland (LSE: RBS) | 23p | 0.4 |
Obviously in this instance, last year's ratios are not worth the paper they are written on. But it is a very salutary reminder of a) just how far the share prices of these once mighty British banks have fallen and b) that banking P/Es really can fall to these tiny levels.
Banks aside, and using forward ratios, there are still many FTSE 100 stocks trading on what looks like ridiculously low valuations.
Company | Share Price | Forward P/E | Forward Dividend Yield |
|---|
| Aviva (LSE: AV) | 288p | 4 | 12.7% |
| Astrazeneca (LSE: AZN) | 2400p | 6 | 6.7% |
| BT Group (LSE: BT.A) | 86p | 5 | 9.7% |
| Royal Dutch Shell (LSE: RDSA) | 1605p | 6 | 7.5% |
Cheap as they may appear, and as high as the dividend yield looks, these are somewhat unprecedented economic times. Aviva for example is being hammered over capital concerns for the insurance sector, and because of their general exposure to a falling stock market. BT's profits are falling fast, has a large and growing pension deficit, and the dividend is under some threat. Shell is at the mercy of the sharply lower crude oil price.
There are no free lunches here, no reward without risk. But I never thought I'd see it.
3. The oil price back down at US$40 a barrel
It wasn't too long ago that oil traded at US$147 a barrel. Back then, common consensus went along the lines of:
- the world is running out of oil;
- world demand for oil is high and only going to get higher still in the years and decades ahead; and
- most of the world’s cheap oil has already been discovered.
At the time, analysts were falling over themselves to predict higher and higher oil prices. Our own Maynard Paton, Chief Analyst at our share tipping service, Champion Shares (try it free for 30 days, with no obligation whatsoever to subscribe), won that particular competition with his tongue in cheek prediction of a $US10,000 oil price.
Today oil trades back around US$40 a barrel. It wasn't too long ago that Merrill Lynch Commodity Strategist Francisco Blanch said "A temporary drop below US$25 a barrel is possible…"
The oil price has recently regained some momentum. But who's to say it can't slump to US$25 a barrel? It has already been below US$35 a barrel, and the global economy doesn't look like it’s a about to take off any time soon.
Over the medium-term, with the marginal cost of discovering a new barrel of oil widely estimated to be about US$75-US$80 a barrel, and oil still being a depleting asset, in a rational market you'd imagine the oil price should eventually get back up to around those levels.
Just don't bank on it happening in the next few months. Fadel Gheit, director of oil and gas research at Oppenheimer & Co. in New York just yesterday said "I do not believe we will see $75 a barrel oil anytime soon…"
Strange times, times I never thought I'd see.
More on the economy, investing and the markets:
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> This article was originally published on 5 December 2008. It has been updated.
> Of the companies mentioned in this article, Bruce Jackson has a small and shrinking beneficial interest in Barclays and Lloyds Banking Group.
