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Oversold, or just plain cheap?

Created:
9 October 2008
Written by:
Geoff Cutmore

Banking scion Baron Rothschild is credited with the entreaty to buy when there is blood on the streets. But then he didn't live through the 25 years it took the Dow Jones Industrial Average to recover its 1929 levels. If invoking the 1930s crash seems like scare mongering, how many more banks need to be nationalised or closed before the gravity of the situation becomes clear to investors still in denial?

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Where is the capitulation low and are historical comparisons useful for the bargain hunters? Monday's 8 per cent fall in the FTSE was the biggest since Black Monday in 1987. On that day 30 years ago, the Dow fell 22 per cent in one session - a clear crash - but two days later it sprang back with the largest one-day recovery since 1932.

But what we have at the moment is more dangerous than 1987 and equity investors are unlikely to see such a strong rebound. Just like 1929, an unfolding banking crisis with a slow and uncoordinated official policy response is morphing into a real economy event. The equity markets are delivering death by a thousand cuts, with large down days matched by smaller percentage bear rallies. Neither buy-and-hold nor market-timing techniques can work well in a panic sell-off.

Calling a bottom, or trend reversal, in this environment is a mugs' game. And there are plenty of analysts such as Nick Carn at Odey Asset Management who think the impending slowdown in corporate earnings growth will weigh heavily on the outlook for stocks. "I think its unlikely equity market levels will be higher than they are today in 18 months time," says Mr Carn.

Tempted by deep value? After all some companies are now yielding more than their PE ratios. Great investors such as Warren Buffet and Sir John Templeton are celebrated for their nerve in buying companies in bear markets. Bold investors know that market prices are starting to look irrational.

Contrarian investing is about liquidity and patience. But also about sleeping soundly at night. If you're tempted to accumulate equities accept that markets could fall further, and if you are buying for yield make sure the target company won't finally be forced to cut its payout to conserve cash. Finally, never be a forced seller - every decision to buy or sell should be yours and not the market's.

Geoff Cutmore presents CNBC Europe's daily flagship programme, 'Squawk Box Europe'. Read his 'Morning Thoughts' blog at www.cnbc.com

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