Get ready for a ride on the double dipper.
I'm convinced that the recent rise by the FTSE is the mother of all dead cat bounces.
Why? Markets instinctively overreact both to good and bad news: what we are seeing is a massive over-reaction to a little bit of good news; the recession appears to have bottomed out. However, here is why I think investors need to be very cautious and take profits now from speculative punts. Perhaps I'm being too pessimistic though, as Bruce Jackson recently warned us about.
1) Unemployment increasing
UK unemployment still has not peaked. On Wednesday the Office of National Statistics published the latest unemployment figures. The number of unemployed people was 2.47 million, up 0.21 million from a quarter ago and 0.74 million from a year before. This takes the unemployment rate to 7.9%. Unemployment is likely to go on rising until it reaches 3 million.
With so many out of work, the multiplier effect will mean that what looks like a weak recovery (albeit driven by government credit) will be constrained.
2) Public sector cuts
The country is heading for a period of massive cuts in public spending to reduce the budget deficit, which will affect all but the super-rich. Whichever party wins the next election, you can expect an immediate round of savage public sector spending cuts that will lead to public sector job losses, strikes and a further reduction in GDP.
While the election of a Conservative government would initially be greeted with glee by the City, the economic effects of retrenchment, when they become evident will ultimately reduce the profitability of FTSE companies, leading to downgrades and losses for many investors.
3) Profits down
It is also becoming clearer that analysts may have been overoptimistic in their predictions on many companies, as sustainable profit growth requires sales growth and there is little sign of that for many companies. Indeed, how can the mass of companies prosper during a recession? Therefore expect a raft of profit downgrades over the next year as the recession really reduces company sales.
Up until now many companies have been reducing their cost base to help support profits but the trick of cutting costs to the bone can't be done more than once.
4) US recovery delayed
It is the US that will eventually drive any economic recovery and the news there is not good. In August the unemployment rate jumped to a 26-year high of 9.7% as the jobless total rose by 0.46 million.
In addition, the US trade deficit is worsening: the most recent trade statistics published by the United States Census Bureau showed that the trade deficit unexpectedly jumped to $32bn in July from $27.5bn in June.
5) Government debt
The Bank of England is pumping £175bn into the UK economy, eventually that is going to have to be withdrawn and when it does interest rates are going to rise substantially. This could choke off a weak economic recovery. Indeed, the only reason we've not fallen into a 1930s style economic depression is because of stimulus packages around the world. The vision that comes to mind is of debt-addicted Britain experiencing 'cold turkey' when the stimulus is eventually withdrawn.
Despite all this, banks still aren't lending businesses the money they need for the economy to recover. They prefer to strengthen their own balance sheets. Bank of England figures revealed that net lending to businesses dropped £0.9bn in June.
6) Stagnant economy
On 25 July, the Office for National Statistics said gross domestic product -- the total value of goods and services in the economy -- fell by 0.8% in the three months to June. The official figures revealed Britain's economy contracted by a record 5.6% over the last year as output fell for a fifth straight quarter.
Since then there appear to be the smallest of green shoots: the National Institute for Economic & Social Research, reckons that the UK economy actually grew 0.2% in the three months to August.
However, this is hardly a return to sound economic growth and in no way justifies the sustained rally we've experienced over the past 6 months.
7) Repossessions rising
In the UK, our sense of economic well being is driven in large part by an estimation of what our houses/flats are worth.
First-time buyers are still priced out of the market and the rate of repossessions is still rising. According to the Council for Mortgage Lenders there were 11,400 cases of possession in the second quarter of 2009, 14% more than the second quarter of 2008. Moreover, possessions are expected to rise in the second half of the year as people come off fixed and tracker deals onto much higher rates and the level of unemployment continues to rise.
For all these reasons I'm very pessimistic about the stock market over the next 12-18 months. I believe what we're experiencing is a sucker's rally. Skilled share prickers may still do ok but it will be tough going. What do you reckon? Am I being too gloomy and has the market priced in all this bad news already? The comment box below awaits your thoughts...
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