Whilst a return to normal economic conditions would be nice, there is a downside. We wouldn’t have nearly as many bargains to choose from.
Wouldn't it be great if this recession was suddenly over?
We could all get back to some sense of normality.
Stock markets would rise and fall by 0.5% on a daily basis and by between 0% and 12% on an annual basis.
The share prices of big FTSE 100 companies like Lloyds Banking Group (LSE: LLOY) and Legal & General (LSE: LGEN) would rise and fall a few percent over the course of a year.
Businesses would grow, steadily. Employers would employ, steadily. Banks would lend, responsibly. Interest rates would rise and fall, slowly.
Consumers would spend, wisely, and within their financial means.
Most of all, confidence would return to the economy. With just a little bit of confidence, the economy could quickly get back onto an even keel, and we could all resume our normal lives again.
Green Shoots Of Recovery…Maybe
Sadly, it's not that easy. We're still in the midst of a major deleveraging, both in terms of businesses and consumers. Stating the bleeding obvious, the economy is going to get worse before it gets better.
Yet, especially in the US, some politicians and economists are prepared to proclaim they are seeing signs of recovery.
Barack Obama said just this week "There is no doubt that times are still tough. By no means are we out of the woods just yet. But from where we stand, for the very first time, we are beginning to see glimmers of hope."
US Federal Reserve chairman Ben Bernanke said he was witnessing "tentative signs that the sharp decline in economic activity may be slowing".
Give Me Hope
Confidence. Hope. Normality. That is what they are trying to bring to the American people, and therefore to the global economy.
The stock market craves normality. It could then get back to the business of valuing most businesses based off somewhat predictable future earnings patterns.
If you could say with certainty that a company like Tesco (LSE: TSCO) could grow at around 8% per annum over the next 10 to 20 years, you'd be able to do a discounted cashflow and value it with a high level of precision, presuming a reasonable average rate of inflation.
Give Me Economic Pain
There is a downside to normality. There would be few stock market bargains, as most shares would be valued by the market at their true worth. Tesco would trade on price to earnings ratio (P/E) of around 16, a fair valuation, but certainly no bargain.
Successful stock market investing is all about buying shares when they trade at cheap prices. It's about buying them below their true value, both to give you a margin of safety, but also so you may benefit exponentially if and when the shares are re-rated by the market.
On the one hand, many of us crave economic normality, a time when our jobs are safer, our house prices are steadily rising, inflation is running at 3%, and consumers are spending.
On the other hand, stock market investors should crave further economic pain. Not because they are sadists, but because they like the share prices pessimism brings. Normality is your enemy.
Forget FTSE 6,750
So what is it to be? The FTSE 100 has had a great run over the past 5 weeks, rising 15% off its low point. Bargain hunters have snapped up shares in beaten down shares like the banks, Xstrata (LSE: XTA), Land Securities (LSE: LAND) and Prudential (LSE: PRU), just to name a few.
Yet the economy remains in a pickle. There may be signs of normality in the US, but at best, 'normal' means 'stopped falling' rather than a return to the debt-fuelled go-go days of 2007.
Make no mistake. The stock market is going to take a hell of a long time to get back to its 2007 level. As a reminder, the 2007 peak for the FTSE 100 was at just over 6,750, in July. With the FTSE 100 currently trading below 4,000, that level seems light years away.
Make no mistake. We are not going to see a repeat of the economic conditions we enjoyed from around 2004 to 2007 for quite a number of years.
On the bright side, what's bad for the economy should be good for stock market investors.
Make sure you are ready, willing and able to take advantage of the opportunities ahead. Whilst it's painful for the economy, it should be beneficial to your long-term wealth.
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> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in Lloyds Banking Group.
