As gilt yields hit a 21-year low, investors are losing faith in shares. Buffett thinks they might be making a big mistake.
The double-dip recession is firmly back on the agenda.
In The Times, Bank of England policy maker Martin Weale was quoted as saying there is a "real risk" of a second recession in the UK. The Bank of England's latest economic forecasts are "putting a significant chance on the economy contracting over a four-quarter period" and that a new financial crisis is a danger that "can't be regarded as trivial".
Yikes. The FTSE 100 took fright yesterday, falling 1.5% to 5,155. It now trades back in correction territory, having fallen over 11% since it breached the 5,800 level in mid-April. As the old saying goes, we should have sold in May and gone away till St Leger Day.
Admittedly Mr Weale's comments weren't the only thing spooking the market, a collapse in US housing sales didn't help, but they most certainly did have the effect of seeing the 10-year gilt yield slump to 2.85%, its lowest level since at least 1989.
8% Interest Rates? You're Barking Mad
Yikes. The capital markets really do seem to be pricing in deflation, and not inflation. I wonder what our friend from Monday, Andrew Lilico, thinks now? He was warning interest rates may hit 8% in two years. I can already see my mock FTSE 10,000 prediction being, well, mocked. Shall we mock Mr Lilico already too?
He probably expects a little mocking. You don't make 'shock jock' predictions and expect to get away with little ridicule. On the contrary, you positively encourage it.
Do you think Mr Lilico is going to be changing his mind, just a couple of days after his extreme forecast? Not likely. Two years is quite some time away, and in this economy, literally anything can and will happen. Watch these spaces…
That said, the economy continues to limp along, just as it did on Monday, just as it did last week, and just as its been doing for some time now. Martin Sorrell, the CEO of the world largest advertising company WPP Group (LSE: WPP), yesterday had his own unique take on the global economy.
A Long Hard Slog
"Whilst politicians, journalists, economists, analysts and investors argue about double-dips, inflation or deflation, the most likely scenario is a slow growth "slog", particularly in the mature geographical markets and traditional media markets, perhaps with inflation and higher interest rates in the long-term."
Slog. I like it.
This stock market is a slog. A little up, a bit more down, capital growth hard to come by, death by a thousand cuts, that sort of a slog. Oh well, at least we did have March 2009 to April 2010 not too long ago, a period when the market went up in an almost straight line, one of the fastest and biggest recoveries known to mankind.
We've had flat periods before. We'll have them again. In the big picture, over the course of years and decades, these slog days of summer will be long forgotten. For now, sit back and enjoy the dividends, and the long evenings, for autumn will soon be with us, as will leaves on the train lines. That will be the time to really get worried.
Do You Feel Lucky?
So what do investors do now? Oil is falling. Gold has come off the boil, presumably because inflation has been forgotten, for now. The stock market is depressed.
In a desperate attempt to find at least one asset class on the rise, investors are flocking to bonds and gilts. Their nominal values rise as their yields plumb new depths.
Do you feel lucky? Do you fancy the sub-3% yield from 10-year gilts? Do you fancy buying gilts when their yields are hitting 21-year lows?
The Latest Bubble?
Some people think bonds and gilts are the latest bubble. I don't think they're in bubble territory, but I'm giving them a very wide berth. Sure, yields could fall further, but over the medium term, I'd suggest the chances of you making a capital loss by investing in gilts today is quite high.
Which reminds me of Warren Buffett's comments from that famous New York Times Op-Ed written at the peak of the financial crisis, October 2008…
"Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts."
He did write it almost two years ago, and he may have a different opinion today, especially as the stock market has already risen 30% since then. But with interest rates at rock bottom and gilt yields at 21-year lows, you can imagine him saying something similar today.
The Missing Link
The stock market is missing a catalyst for it to move significantly higher. The obvious fact that blue chip shares like Vodafone (LSE: VOD) and J Sainsbury (LSE: SBRY) have dividend yields significantly above gilt yields is not enough to do it. We have to see rising house prices and/or falling unemployment, either here or in the US, and right now, there's more likelihood of Liverpool winning a game of football than those things happening.
Speaking of housing, and the US, yesterday sales of existing homes plunged 27.2% in July compared with June, their lowest level in more than 10 years. It hardly smacks of economic recovery, although the expiry of tax credits for homebuyers was a big factor in the drop. Still, it's no wonder the double-dip recession is back on the agenda.
More Double Dipping
Adding fuel to the fire, Chicago Federal Reserve Bank President Charles Evans said on Tuesday while a new contraction in the economy is still not the most likely scenario, high unemployment and a fractured housing sector make this recovery a fragile one. "A double dip is not the most likely outcome but I am concerned about how strong the recovery will be."
It's a slog.
Investors are seemingly losing faith in the stock market. These are likely the same investors who were euphorically investing in shares back in April, when the FTSE was riding high.
At the rate we're going, they're likely to really hit the panic buttons if and when the FTSE plunges below 4,800, freaked out by some chartist calling for a Fibonacci retracement, or some such nonsense. Anyway, I thought Fibonacci was Man City's latest signing.
This Is How You Can Lose Money
Before you sell out in boredom, panic or fear, I'll leave the last word to Buffett. Quoting again from that October 2008 Op-Ed. In the 20th century, the Dow rose from 66 to 11,497.
"You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy."
You decide.
More on the economy and the markets:
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> Bruce Jackson has an interest in Vodafone.
