ONWARDS and upwards goes the great stock market rally. Despite oil prices climbing to $83 a barrel, a slowing housing market and a downgrading of the government's growth forecast for next year, the FTSE 100 climbed a further 134.9 points or 2 per cent last week to close at 6,730.7.
That's just a whisker from its 2007 high and prompts the question of whether the great global credit crunch actually happened or was just a bad dream.So why has the marked rebounded so strongly? Have we been too gloomy about the impact of the credit crisis on the wider economy? And what should investors do now?
There will be many reminders this week of the 20th anniversary of the 1987 stock market crash. On Monday 19 October 20 years ago, the Dow Jones Industrial Average plummeted 23 per cent. Markets round the world followed. By the end of October, the UK market had fallen by 26 per cent and Hong Kong by 46 per cent.
But as surprising as the crash was the recovery. Unlike after 1929 (the precedent most widely cited at the time) markets rallied almost immediately. Wall Street posted a record one-day gain of 102.27 points the next day and 186.64 points on 22 October. It took just two years for the Dow to recover completely - by September of 1989 the market had regained all of the value it had lost in October 1987.
In Britain, too, the market recovered as interest rate cuts drove the Nigel Lawson boom to a final climax before a spectacular bust in 1990-92.
This time around the FTSE 100 tumbled 857 points or 12.7 per cent between its June 2007 high of 6,716 to its 16 August low of 5,858.9 It has now clawed almost all of this back.
Yet evidence has mounted of slowing mortgage lending, a gathering slowdown in the rate of house price growth and signs of slower activity across the economy overall. Last Tuesday Alistair Darling, the Chancellor, cut the official 2008 forecast for the UK economy from growth of between 2.5 and 3.0 per cent to 2.0-2.5 per cent. Yet the market seems to have shrugged this off.
This has much to do with the strength of the mining sector, as the giant natural resource companies in the FTSE 100 such as Anglo American and Rio Tinto have forged ahead on the continuing commodity price boom. Housebuilders, property companies, retailers and financials have all been left behind in the rally.
Big drivers in the FTSE 100 over the past week were oil giant BP, which gained 8 per cent to 619p, and crisis-hit Northern Rock, which soared 73 per cent to 273.5p on talk of interest from potential bidders including Sir Richard Branson's Virgin Money. The "downers" were Royal Bank of Scotland, 4 per cent weaker at 546p on worries that it had overbid for ABN Amro, and Barclays, which slipped 2 per cent to 648p.
It is by no means the first time the stock market has gone one way and the economy another. One of the worst years for the British economy was 1975, when inflation hit 25 per cent. But the FT30 Index doubled that year as it recovered from a historic sell-off that left shares in some of our biggest companies as cheap as chips.
Today's market recovery has been driven in large part by developments in the US where the Federal Reserve moved promptly to cut interest rates by half a percentage point. Recent economic data has been less bad than feared. Non-farm payroll numbers came in higher than expected while last Friday brought a fairly solid retail sales report. This convinced investors that the consumer sector might remain a bulwark against a more pronounced economic slowdown driven by the housing slump.
These developments, combined with a good flow of corporate earnings news, has helped the Dow to hit new highs. And over in continental Europe there are signs that the German economy is bucking the more dire prophecies of slowdown. All this is working to confirm many investors in their belief that global markets are locked into a major bull run that is likely to last for another three years. Slowdowns, they argue, will be cushioned by the continuing strength of the Chinese and Indian economies. So you don't want to be out of equities at this time.
However, others are more sceptical. They fear that they are being drawn in to a sucker's rally and specifically a "1999 trap". The world economy was performing well, stock markets were driven ever higher by the dot-com and information technology boom, and everything was set fair as the millennium approached. But then the dot-com bubble burst, a three-year bear market ensued and even now the FTSE 100 has still to reach the all-time high it hit at the tail-end of 1999.
It would be surprising if there was not some profit-taking after the recovery of the past six weeks. Much would then depend on the outlook for interest rates and the consumer sector.
For the moment there are still sectors of this market to be avoided until conditions are more clear. Investors need to pick carefully those companies with solid earnings growth prospects and a commitment to dividend payouts.
Source: Scotsman.com
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