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Will shares recover in 2009?

Created:

17 December 2008

Written by:

Jonathan Eley

Few of us will forget 2008 in a hurry. The scale of losses from bad or unrecoverable debts is barely comprehensible, while falls (or rises) of 5 or even 10 per cent a day in stock markets have become almost routine. Every crisis brings opportunities, but our question this week is whether 2009 will be paradise for bargain-hunters, or just a suckers' rally within a multi-year bear market.

YES, says Michael Dicks, head of research and investment strategy, Barclays Wealth:

"Let me first be very clear about what we are not saying. We are not predicting that shares will start marching north on 1 January. We are not under-estimating the challenges that UK plc faces - if anything, it will be harder hit during 2009 than many other countries - and we are certainly not cheerleading for the stock market.

But we do maintain that valuation, momentum and the economic backdrop all point to equity outperformance in the future. The road to this rehabilitation - and it will be a long, hard slog - is likely to start in 2009. Our forecast for the FTSE100 is for a 14.6 per cent rise from January to December, with much of this gain weighted towards the second half of the year.

The backdrop to these predictions is an economic outlook that is bleak, but not apocalyptic. We recognise that high debt-to-income ratios mean that the shift to saving is likely to be more pronounced here than elsewhere, with obvious consequences for consumption. And not surprisingly, we concur with John Varley's view that we have not yet seen the bottom in the housing market. We expect four further quarters of negative GDP growth followed by an anaemic economic recovery in 2010.

So when should you re-enter the market, and what sort of shares should you buy? Equity markets tend to lead the economy by a couple of quarters, and looking at a range of economic indicators helps to predict the turning point. Our analysis here argues against taking a more aggressive stance on equities, until the end of the first half of 2009. When appropriate, we would look adding high-beta 'growth' and 'cyclical' stocks to portfolios, rather than the 'value' shares that are currently in vogue. The logic is that growth outperforms value coming out of a recession, whereas the reverse is true going into one.

In conclusion: the first half will be very tough, and other developed markets will recover quicker than the UK. But although it might not feel like it right now, things will get better in the stock market, and that process will start next year."

NO, says Jonathan Eley, online editor, Investors Chronicle

"After a year of financial meltdown, the like of which most people would only expect to see once or twice in a lifetime, it's tempting to think that the nightmare must soon end and recovery begin. And so it will - but I'm far from sure it'll be next year.

There are several reasons why this is the case, and they are ones that many of my IC colleagues have already alluded to. Chris Dillow, for instance, has pointed out that big falls in shares during one year do not necessarily indicate a recovery the next. If you'd bought shares at the end of 1973, you would not have been quids-in during 1974 - in that bear market, shares fell by almost three-quarters from peak to trough. At its lowest point this year, the FTSE100 was 44 per cent below its 2007 peak, and right now, it's "only" 36 per cent off.

Simon Thompson has pointed out that if shares appear cheap at the moment, it may only be because the earnings expectations used to calculate such yardsticks are inflated. The first quarter of 2009 is likely to see a series of profit warnings and dividend cuts, and a further downward leg of the bear market.

At that point, shares might indeed be genuinely cheap. But who is going to buy them? Not the companies who fell over themselves to borrow money to buy back shares when the market was rising. Not the private equity groups, whose debt-funded takeover binge injected billions into the market during 2006 and early 2007. Not the hedge funds, who are being hit with huge redemptions. And almost certainly not the private investor, for whom fear, rather than greed, is likely to be the dominant emotion for 2009.

Yes, returns on cash are low, but not that low, when you allow for low inflation, or even deflation. Equity yields are higher than bond yields, but so what? That's been the case in Japan for years, but equity markets there haven't recovered.

Investors have come to expect ludicrously high returns from many asset classes. With smoke, mirrors and a generous amount of monetary greasing, the financial markets have hitherto 'met' these expectations. But now they've been found out, the hangover is going to be a long one."