Fun on the big dipper

Since the FTSE All-Share index peaked at 4269 in mid January, its value has fallen 7.5 per cent. Imagine that period as a calendar month and there have been a couple of instances – May 2012 and August 2011 – when the All-Share index came within touching distance of falling by that magnitude. But you have to go back well over nine years – to October 2008 as Lehman Brothers was imploding – to find a month that suffered a steeper drop.

So what’s unusual is not what has just occurred, but the spookily-long period when equity markets were all calmness and equanimity. Let’s quantify that. Taking January 1990 as an arbitrary start date, there have been 12 occasions in the 337 months since then when the All-Share index fell by at least 7.5 per cent (and, for what it’s worth, four times when the drop exceeded 10 per cent). Thus, on average, the market drops by at least 7.5 per cent every 2-and-a-quarter years. And if the instances had occurred with beautiful regularity, we would have seen four 7.5 per cent falls during this nine-years-plus when there has, in fact, been only one.

The cynical response might be to say that such placidity is a tribute to the central bankers who – via vast amounts of quantitative easing – were determined to see that their pals in the financial markets came out of the crisis alright even if no one else did. More important, is the current weakness the start of a proper bear market? If so, then there’s still a way to fall. In the past two instances of what we might label a ‘mini bear market’ – a sharp but short shock – the All-Share dropped 30 per cent from peak to trough in mid 2002 and 24 per cent in mid 1998. True, since the turn of the century there have been two sustained bear markets, the first from September 2000 to March 2003 and the second from June 2007 to March 2009. Coincidentally, in both, the All-Share’s peak-to-trough fall was 49 per cent.

Granted, there seem no glaring reasons why the current weakness should portend a lengthy bear market. Prolonged near-zero interest rates and the continual drip-feed of quantitative easing may have inflated asset prices to unrealistic levels. But this does not seem to come close to the excesses that built up during the late 1990s, when speculation was largely confined to the equity markets, and especially during the mid 2000s, when madness infected the whole financial infrastructure.

Besides, today’s concerns seem more like those of old where investors fretted about the effects of economic overheating – pressure on profit margins, rising inflation and higher interest rates. Compared with the past 10 years, this seems a nice problem to have. But simply in terms of their ratings, equity markets could have a long way to fall. The much-followed ‘CAPE’ smoothed PE ratio for US equities devised by Princeton University’s Robert Shiller stood on a multiple of 33 at the start of February, 50 per cent above its average for the past 40 years. So a spot of mean reversion could play havoc with share prices.

That investors don’t quite know what to make of it all is implied by those companies in the FTSE 350 index whose share price has fallen the furthest since the peak on 12 January (see the table for the worst-performing 10). Clearly it was a bad time to confess to company-specific problems as the selling started; each of the three whose shares performed the worst have issued serious profit warnings since the start of the year. More than that, those who are known to be weak have been picked upon – the likes of AA (AA.) and Provident Financial (PFG) among the 10, but also Petrofac (PFC), TalkTalk Telecom (TALK) and Mitie (MTO) just outside it. 

Whether this affords buying opportunities is another matter. With the outlook especially uncertain it may well be too early, but instinct says that in respect of funerals operator Dignity (DTY), which has been found wanting by a brilliant piece of investment analysis by a competitor, mail-order retailer N Brown (BWNG) and IT services provider Sophos (SOPH), it could be worth doing some detailed though open-minded number crunching.