What next for shares? Predictions from the world's best stock market experts

By Andrew Oxlade
UPDATED: 04:29 EST, 23 January 2012

 

This is Money Editor Andrew Oxlade [@andrew_oxlade] takes you through the rollercoaster ride of recent UK stock market fluctuations. We tell you:
• The history
• Who predicted the crash
• What to expect next (and a word of caution on predictions)

 

Summary: What happened in 2011

The FTSE 100 fell 6.5 per cent in 2011 following a 10 per cent rise in 2010. That's disappointing - but it's better than the 15 per cent tumble for Germany and 17 per cent for France.

The bad debts of banks that crippled the financial system have been passed on to governments (and their taxpayers), hence the sticky mess that emerged last year [ more on Britain's debt woes ].

Now debt threatens to bankrupt several southern European countries - this reality only sunk in during the summer of 2011 and was the reason for the poor performance of the stock markets in the second half of the year. The FTSE 100 hit a low of 4935 on 19 August - a 20 per cent fall from more than 5900 in July.

Fresh hopes for a rescue package pumped markets back up in late October: the U.S. market had its best month since 1974. But the exuberance evaporated in November and December when a solid plan to save the euro continued to evade European leaders.

We set out reasons for pessimism and optimism (which have barely changed in three years):

The bull points

• Central banks will stimulate economies with printed money at the slightest hint of trouble, and this has the side-effect of increasing demand for assets such as shares;

• Shares look very cheap vs bonds. When FTSE 100 dividend yields exceed 10-year government bonds, it means shares are a buy. This happened in late summer 2010 and again in the second half of 2011. Others say this measure is flawed because bond yields are depressed by low rates and money printing (QE);

• Inflation is high - a period of gentle price pressure can be good for equities;

• The emerging market boom might continue, keeping the West out of recession.

The bear points

• A fresh boom in China helped pull the world economy back from the brink. That economic charge may be slowing - the jury is out;

• A recovery in house prices has ended. A second wave of falls, leading to more bad debts, could spark another waves of bank failures or another credit crunch;

• Governments took on too much debt in the boom years, and bad debt from banks, and some could fail to meet repayments; We've been highlighting this here since 2009 but it became very apparent with with eurozone crisis in 2011-12.

• Spending cuts in the UK could hamper demand;

• Deflation may take hold, leading to a falling spiral of consumer and asset prices, including shares (another long-standing point that has been dismissed but deflation fears were back with a vengeance in 2012.

The FTSE 100 in 2011

 

›› 30-second guide: Beware stock market predictions (including ours)
›› Interactive FTSE 100 charts

 

What next for shares?

Latest views from the best financial pundits

We've expressed caution every time the FTSE 100 has been in the range of 5500 to 6000 points, when it's looked ripe for a sell-off. This position has worked extremely well in the past two to three years. Even when the Footsie's been at those lower levels there have been better long-term opportunities to be had in emerging markets.

My view, evident also in our predictions round-ups on rates and the economy , has remained the same in recent years: Crippling government debt and weak economic prospects, due to ageing populations, mean Western countries are likely to see wealth stagnate for at least a decade - so rates will remain low and assets such as property and shares will endure a slow decline, relative to inflation. Read my forecast from 2009, when many others were rejoicing a nascent recovery in the economy: My predictions for 2020.

So would do others say?

One of the City's new prophets is Dylan Grice at SocGen. He, along with colleague and Albert Edwards , established themselves in the media for making thought-provoking (and gloomy) assertions in 2011.

Before the summer turmoil they suggested the US stock market was 50 per cent to 60 per cent overvalued against the long-term average and that investors have now missed the boat with pumped up emerging markets. Edwards said then that shares could fall by up to 70 per cent. He has warned before: in August 2010 he predicted an 'equities bloodbath' .

However, in January 2012, ultra-bearish Edwards said this could be the final year of pain, that China would collapse sparking further stock market losses globally - and buying opportunities. 

Read more: The Economist on Edwards |

Nouriel Roubini - the so-called Dr Doom who predicted in 2006 that the world would suffer a bank-induced meltdown - warned (2 Nov 2010) that house prices would fall further and economic growth would be anaemic. Previously, he warned global shares will fall 20% . Perhaps most presciently, he warned in May 2011 that stock markets were at a 'tipping point' . They plunged in July.

The bottom line is that many Western governments are sitting on massive debts - paying those down will erode economic growth for many years [ Why the FTSE 100 may still be at 5000 in 2020 ]. Some countries, such as Greece, may be already caught in a recessionary debt spiral.

How cheap is the stock market?

Experts use various methods to value stock markets . The most popular is comparing the total value of the market against the profits made by the companies listed on it. This is known as a price-to-earnings ratio - the lower, the better.

Research from Citigroup on European stock markets as a whole suggests there have been only two occasions when shares have been cheaper – 2008/09 and the 1970s. [Read more on this - and on how to find solid shares]

Broker Charles Stanley valued the UK stock market in December 2011 on a modest 9.2 times, based on the estimate earnings of companies for 2012.

In theory, that's cheap given that the long-term average is closer to 15.

Richard Buxton, head of UK equities at fund manager Schroders, says investors should ignore the economic woe and focus on valuations: 'Ten years ago the market stood on a price/earnings ratio of 24 times. Today, it trades at a valuation of 9 times earnings. Crucially, starting valuations are the key to future returns - not the economic backdrop.'

In January 2012, Merryn Somerset Webb of the FT wrote th at the p/e ratio in the U.S. was 14 times, 11 in the UK; 10.3 in France and 9.7 in Germany.

She also says emerging markets are cheaper with China on a ratio of 8. But adds: 'I would argue that, for now at least, most emerging market indices should trade at something of a discount to developed market stocks.'

The problem with p/e ratios is that they rely on brokers' estimates of the profits that will be made in the future - they could be wide of the mark, especially if the economy is weaker than expected.

Another measure is the average yield, the amount being paid out as income by companies relative to the cost of buying their shares. A typical yield for UK shares has been around 3.5%. Charles Stanley puts this today at a favourable 4%.

When this yield rises above the level of income paid on government bonds, called gilts, it is also seen as a rare signal and one that suggests it is time to buy.

But again, this measure is debatable. Critics argue that bond yields have been artificially depressed by the Bank of England's money printing programme. The yield on the Footsie has exceeded the UK gilt yield several times in 2011 with little sign of it triggering a rally.

One other measure which has a growing numbers supporters is to take the price-to-earnings ratio and smooth out the effects of the business cycle by taking an average over a decade. This is known as the cyclically-adjusted price-to-earnings ratio (CAPE).

It's hard to get this ratio for the UK but U.S. broker Andrew Smithers of Smithers & Co has a reputation for producing a regular valuation for the American market. In September 2011, his calculations suggested it was 38 per cent over-valued.

But even this method has its flaws - and its critics. CNN journalist Jeffrey Westmount points out some hol es in it here .

Respected analyst Jeremy Grantham warned in May 2011 that stocks were 40% overpriced .

The highly regarded U.S. economist Robert Shiller , who came up with the concept of CAPE , estimated in September 2011 that the US market was 21 per cent too expensive, based on his CAPE measure.

Bill Bonner , a pathological pessimist who correctly called the decade-long bull market for gold, is also, unsurprisingly, very bearish. He says the stock market is undergoing a long correction and suggests there's another six years to run.

Money Week, the magazine where Bonner is publisher, also had this to say in mid-December: 'CAPE has declined from its record of 45 [in 2000] but it has yet to fall to the single-digit levels that mark the end of long-term bear markets: it is still around 20, far above the average since 1881 of 16.4. This suggests the bear [market] has unfinished business.'

Ben Funnell, chief equity strategist at GLG, argues that stock markets  this side of the Atlantic, are better value. He said: 'On the Shiller P/E measure... U.S. equities look really expensive on a reading of 19, while Europe appears to offer better value on 12. Should European stock markets fall around 30% from here, the opportunity in equities would begin to look incredibly compelling on a Shiller P/E basis.'

Of course, just because a market is cheap doesn't mean it will rise. It could just stay cheap for years - or get even cheaper.

There are also some interesting views [click here] gathered by Matthew Vincent of the FT on why the FTSE 100 would only become 'cheap' at 3900 points.

The FTSE 100 in the decade to July 2011:

Archive: Forecasters who called it right in 2010-11:

• Bank of England report: shares to fall 20%
• Roubini warns global shares will fall 20%
• Star manager Ted Scott's fears for the market
• The no-win scenario for shares and property

Some older predictions

We aim to gather views that matter, from those with a proven track record of calling the market right, or at least those who get it right more than the norm:

• Key bullish views:
›› Warren Buffett: 'Shares are far cheaper than bonds'

• Key bearish views:

›› Albert Edwards: Stock market 'bloodbath' lies ahead
›› Bill Bonner: Stocks at start of a major adjustment over six years
›› 'Dr Doom': Rally reversal in late 2010 [ More Roubini gloom:June 2010 ]
›› Shares guru Woodford warns on stock markets
›› The Economist warns on shares 'bubble'
›› Ditch shares, says prophet of doom IFA
›› Why the market is 20% over-priced

It's also worth keeping an eye on the Roubini index [thestreet.co.uk]

• The inbetweeners
›› Bolton was bullish. Now he's not
›› Jim Rogers: UK is dead. So go east!
›› How to spot when a bear market turns bull

 

The history: Why stock markets crashed

The five-year share boom (since the 3250 Footsie low of March 2003) ended on 21 January 2008 when the FTSE 100 endured its biggest fall since the 9/11 attacks of 2001, crumbling from 6400 points to less than 5600 within a month. The trigger had been the collapse of of US investment bank Bear Stearns.

The credit crunch, which began in August 2007, started as a phoney war for shares.

Even after that, markets enjoyed a powerful recovery from mid-March to mid-May, with the Footsie rising nearly 20% to more than 6400 points. It was a 'Wile E Coyote' moment, legs spinning and running off a cliff.

The root of the problem went back a decade. Excess money from the cash-rich Chinese and Far East economies sloshed into Western nations, fuelling a consumer boom based on debt. This was stoked further by interest rates being set too low in the West.

The first signs of stress emerged in 'sub-prime' mortgage lending in the U.S. The banks, which had done all the lending, suddenly woke up to the severity of the crisis at the end of summer 2008, with the collapse of Lehman Brothers. The FTSE 100 plunged from 5600 at the start of September to below 3800 by early November.

The episode had already sparked a severe recession. The FTSE 100 fell more than 10% at one point on 10 October . Personally, I was enticed back to investing again on 12 October in bombed out emerging markets. [Why I invested] . Warren Buffett gave the markets some support by revealing on 16 October that he was bullish and buying US shares .

The Footsie bounced, then fell again to a five-year low of 3,512 in March 2009 before mounting a powerful rally 73% rally over the following two years.

Who predicted the shares slump?

Back in 2007, when markets remained fairly oblivious to the growing storm, we reported (see below) on warnings of bad times from eminent financial pundits.

These are people with a track record of successful investing (and I've also thrown in some of my own views). However, take all stock market calls and predictions with a pinch of salt (30-second guide: Beware stock market predictions) as even the world's most revered stock-pickers get it wrong. Read about UK managers making the wrong calls .

The bottom line is that markets, by nature, are erratic and unpredictable. Nassim Taleb explains this well with his Black Swan Theory | Don't miss: A 30-second guide to Black Swan Theory

For my part, I have UK fund investments but far more money invested in emerging markets - a higher-risk strategy: Latin America | why I like emerging markets . I believe these regions will now pick up the baton from developing countries (see below). It paid off in 2009 and 2010 but not in 2011. That pullback should not bother long-term investors - I expect the investments to win over the next 20 years.

Don't miss our turbulence test : 'Should you sell?'

Stock market crashes from history

- This is Money's Dan Hyde gives a full plotted history of stock market crashes since 1720.

- And we explain how this crash compares to 1929 and the depression that followed (Oct 2008)

Views from BEFORE the stock market falls of 2008

›› Jeff Prestridge: I'm following the smart money
We reported of a warning of an imminent collapse of equity markets akin to that of 1973 and 1974, when the UK stock market fell by 73% (Dec 07).

›› FTSE 100 'could fall 1,200 points in 2008'
Morgan Stanley's warning was spot on. And don't miss a full round-up of predictions from December 2007 .

›› Shares guru warns of crash
Anthony Bolton, arguably the UK's best stock-picker, warned of dire times. But he first warned (prematurely) of a crash in 2006 (Jan 2008).

›› Sex, population and the predicted share crash of 2008
In 2002, we highlighted a theory that claimed to accurately forecast stock markets. The prediction? A prolonged slump in shares and house prices to begin in 2008. [ Updates on this ].

›› Soros and Greenspan warn 'US faces crisis'
Former Federal Reserve Chairman Alan Greenspan and billionaire investor George Soros warned of a serious crisis ahead (Nov 07).

›› Buffett warns on derivatives in 2003
Yes, of course the greatest investor of our age had seen it all coming years before, warning of 'financial weapons of mass destruction'.

 

 

 

This commentary was written by This is Money Editor Andrew Oxlade and is updated as market events dictate.
Twitter: @andrew_oxlade

• This round-up was first created in January 2008 and has been downloaded more than one million times.