You just don't recover from The Great Recession in a matter of months. There will be more tough days ahead for the stock market.
The stock market might suddenly be coming to its senses. Yesterday was a big down day, with the FTSE 100 dropping 112 points or 2.6% to 4234. The US markets saw our 2.6% and raised it, the S&P 500 falling 3.1%.
The stock market rally from the March bottoms was well and truly justified. The valuations of many good companies got to ridiculously low levels as panic gripped the markets. Brave buyers who jumped it whilst all others were selling or just watching were well rewarded.
Too Far, Too Fast
But the market got ahead of itself. From the March bottoms, at one stage the FTSE 100 was up over 30% in just 2 months. In the midst of what most people agree is the worst recession since the Great Depression, that jump seemed like too much too soon.
It was lead largely by stocks that had fallen the most. At one stage Barclays (LSE: BARC) was up over 500% from its bottom. 500%? For a FTSE 100 company? I doubt in my lifetime I'll ever see such a massive surge for such a large company in the space of just a few months. As I've recently written, I took the opportunity to sell my entire holding in Barclays at around 300p.
Resource stocks also went on a tear, buoyed by rising commodity prices. Many investors took the view that the massive government sponsored stimulus packages in countries like the US and China would result in strong demand for commodities like iron ore, copper, zinc, platinum and oil. Vedanta Resources (LSE: VED), Kazakhmys (LSE: KAZ), Rio Tinto (LSE: RIO) and Xstrata (LSE: XTA) were some of the biggest winners.
Reality Strikes
But yesterday, reality struck. It came in the form of World Bank's latest missive on the state of the world economy, titled "Global Development Finance: Charting a Global Recovery."
In a nutshell…
- Global GDP seen contracting by 2.9% in 2009.
- International trade experiencing the sharpest drop since World War II.
- Subdued recovery in 2010, with 2% global growth expected.
- Increasingly grave economic prospects in low-income countries if capital flows don't improve.
Those stark forecasts spooked the market in a number of ways…
1) The forecasts compare with a prior estimate of a 1.7% decline in 2009. Things are getting worse, not better. Yikes.
2) Growth of 2% in 2010 compares with 2.3% forecast about three months ago.
3) The green shoots of recovery are not going to turn into massive oak trees by the end of this year or the early part of next year.
4) Investors are coming to the reality that company profits are unlikely to bounce back to the heady levels of 2007 in the near future. We all need to get used to the "new normal".
Take Marks & Spencer (LSE: MKS) for example. In the year ended March 2008, M&S made pre-tax profits of over £1 billion. In the year ending March 2011, analysts are currently forecasting pre tax profits of just £550 million. This is no V-shaped economic recovery. It will likely take many years, if not a decade, for M&S profits to reach their 2008 peak. This is the new normal.
Reality Hurts In Many Different Ways
Reality hurts. But it should be no surprise. You just don't bounce back from a Great Recession in a matter of months. It will take years for the excesses of the finance bubble to work their way through.
Look at your own situation. If you still have a job, you are lucky. But you likely won't be expecting much in the way of pay rises in the next couple of years, let alone bonuses.
If you have a defined contribution or a self invested pension, it has likely taken a 20-30% haircut over the past 18 months. Suddenly, your retirement isn't looking as financially comfortable. Likewise, your share portfolio has been decimated, falling by more than 30%.
Then there is property. House prices are down across the board. Although it may not directly affect you too much regarding the house you live in, indirectly it removes some of the feel-good factor many people enjoyed during the Great Housing Bubble of circa 2003-2007.
The Bottom Line
The World Bank report has pricked the stock market bubble, for now anyway. It remains impossible to predict the day to day movements of the stock market, but I have a feeling we may be in for some tough days ahead.
Of course, that doesn't mean you should sell everything and wait for the next market crash. As I've repeatedly said, there are still some quality stocks available at cheap prices. Buying them today, and continuing to average into them if the market falls, remains a sensible and hopefully profitable strategy.
Just don't expect to get rich quickly on a V-shaped economic recovery.
More on the economy and the markets:
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> Bruce Jackson does not have an interest in any of the companies mentioned in this article.
