August 2006 Investment Report
RECESSION = FALLING INTEREST RATES AND STOCKMARKETS
Of the six previous peaks of rate tightening in the USA in the past 35 years (April 1969, April 1974, February 1980, February 1989, February 1995 and May 2000), five were followed within twelve months by the onset of recession. That is an average of peaks in interest rates every 6.2 years. Another peak is due and interest rates may be expected to fall.
Russell Napier, author of ‘Anatomy of a Bear’ has worked out that troughs in stock markets all came towards the end of a recession, when the news was no longer bad but looking up nicely and the papers were full of bullish comments. Napier also notes that bear markets take on average 14 years to move from trough to peak. They don’t end until the market in question is valued at a 70% discount to the cost of replacing all the assets it represents. Stock markets are still valued above their net asset values. To Napier this suggests that rather than ending in 2003, the bear market in America may have only just begun.
Any rally in the US and UK stock markets is unlikely to last very long.
Newton Investment Management believe that despite the focus on there being spare capacity, in aggregate, US industrial capacity use is still below its pre-2000 average of 82% and while unemployment is low there is no sign of rising unit labour costs, as the use of technology continues to improve the productivity of workers. With evidence mounting that US consumer spending is sagging under the combined attack of high and rising costs for essential items (hence restricting discretionary spending power) and falling house prices (that limit the ability to raise credit) any impact is more likely to be felt on profit margins as companies compete for market share. Any inflationary pressures are likely to be fleeting and ignored by investment markets as the consumer-led slowdown in activity becomes more evident.
The latest report of Andrew Smithers, author of ‘Valuing Wall Street’, is gloomy about the medium term. ‘Asset prices are out of line with incomes; in the absence of a marked rise in inflation, a return to equilibrium requires a fall in nominal asset prices’. ‘Below trend growth is likely to be accompanied by falling profits, as equity markets are seriously over-valued, there is a large risk that falling profits will cause further declines in the stock market, which will in turn increase household savings, partly through requiring higher pension contributions from companies, which will set off further falls in profits and share prices.
Dresdner Kleinwort Wasserstein says its monetary conditions indicator is at its lowest level for two years. It says this points to an imminent slowdown in global growth.
The deputy governor of the Bank of England, Sir John Gieve, has recently warned of an increase in risks facing the financial system. ‘The financial system cannot reduce the amount of risk in the economy, but only repackage and transfer it. As more instruments that transfer risk are added to the balance sheets of financial institutions, so leverage and connectivity grow’. He pointed out that while the dispersal of risk throughout the system might reduce the likelihood of financial crises, it would also ensure a future crises would spread more widely. ‘We may be moving to a world of less frequent but higher impact crises’ Sir John said.
Gold
Gold Field Mineral Services Limited believe that in the shorter term it is possible that the recent liquidations, which have brought the gold price to well below the $600 mark, will be followed by a modest recovery in the price, with gold then likely to be more range bound over the rest of the summer. In the latter part of the year and through 2007, they expect investment demand will return strongly, pushing the gold price to fresh highs. Given the US dollars poor fundamentals, rising energy and commodity prices in general, and increasing geopolitical tensions, the investment case for gold remains powerful. Given the ever widening investor base for commodities, the potential ‘weight’ of money that could enter the gold market is immense. To date this rally has involved a small minority of institutional and private investors. Indeed, should the inflow of new money into gold prove sufficient, there is even a good chance that the 1980 nominal high of $850/ounce will eventually be taken out.
The views reflected herein are those of Mitchell Neale Investment Services and should not be regarded as a recommendation to invest in any product or service; before investing you should always consider personal investment advice.
Mitchell Neale Investment services does not accept any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. Investors should be aware that the value and income from investments can rise and fall and that past performance should not be considered as a guide to the future.
Mitchell Neale Investment Services
2nd August 2006