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Friday 30 September 2016

Is a stock market meltdown imminent?

The IMF has warned that share price mayhem is around the corner. Is it right? asks Louise McBride

Published 24/04/2016 | 02:30

The IMF has warned that share price mayhem is around the corner. Is it right? Cartoon: Tom Halliday
The IMF has warned that share price mayhem is around the corner. Is it right? Cartoon: Tom Halliday

Years of stock market mayhem could be just around the corner if governments don't take action now to halt a fresh economic crisis, the International Monetary Fund (IMF) warned earlier this month. Should this financial crisis erupt, shares in Britain, the United States, the eurozone and China will lose a fifth of their value over two years, according to the IMF.

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This warning comes at the same time as many investors continue to lose money on the back of low oil prices and as fears about the impact of a possible Brexit intensify.

Should investors be worried by the IMF cry?

"The IMF was making some sensible warnings - and it is not alone in doing so," said Andrew Milligan, head of global strategy with Standard Life Investments."Other central bankers are also worried that monetary policy is no longer proving as effective at driving forward economic activity as it has been in the past."

If we don't see better responses to economic problems from governments around the world, the IMF's warnings could come true, according to Milligan.

This could see a return to the stock market mayhem of 2008 and 2009 - or worse.

"The really scary thing about this is that if we do get another 2008 to 2009 crisis, there's nothing to fix it this time," said Peter Brown, director of financial trading with the Institute of Investing & Financial Trading in Dublin.

"European interest rates are zero, so the European Central Bank can't cut interest rates. And quantitative easing (printing money) will be seen to have been a failure. So it would be a catastrophic collapse if we were to go again - worse than the 2008-2009 crisis."

Are we really on the verge of a bear market?

Most of the investment experts this paper spoke to don't believe we're on the verge of a bear market - where stocks typically trade at prices that are at least 20pc below their peak. Rather, they believe there are a few years of low stock market returns ahead - albeit with a number of scary corrections along the way. (In a correction, stock markets typically fall by 10pc).

"Equity markets have been under considerable pressure but over the last few weeks, a lot of that pressure has eased," said Milligan.

The first two months of this year were disastrous for stock markets. By the middle of last February, several of the world's leading stock markets had fallen by more than a fifth from their peak of 2015.

"Depending on where you are investing in the world, you may have already just come through a bear market," said Brian O'Reilly. head of global investment strategy with the stockbrokers, Davy.

"The IMF is alluding to the view that the European banks don't have their house in order. We would have some sympathy with that view. But the banks are in much better shape today than a few years ago."

How near could we be to a recession?

It is the prospect of another recession - as signalled by the IMF in its latest warning - which stock market investors have most to worry about. Recessions and bear markets generally go hand in hand. However, Davy believes it will be 2020 before the next recession hits.

"Recessions are inevitable and there will be one at some stage but we don't think there's a recession around the corner," said O'Reilly. "We estimate we are about three years away from a recession."

Of course, if governments don't take action now to drive economic growth and stymie the problems highlighted by the IMF earlier this month, there are a number of well-respected experts who believe we could have another recession on our hands soon.

Should I pour my money into stock markets even if a recession is a few years away?

Even if the world avoids a major downturn, it will still be quite hard to make money on stock markets over the next few years - because investment returns will be so low, according to Milligan.

"This is a world of low numbers - for economic growth, inflation, interest rates, bond yields, dividends and so on," said Milligan. "So investors need to be aware of the implications for their portfolios. Stock markets are not always in a bull or bear phase - they can trade sideways for a long time. The world of low returns is a difficult one for companies to operate in. Questions have to be asked about their ability to pay dividends and so on."

Brown believes there will be a few stock market corrections over the next year or two and that markets could fall by as much as 15pc when they occur. While he doesn't feel we're on the verge of a bear market, he too expects returns over the next couple of years to be low. Investors must take a more hands-on approach to the stock market as a result, he advises.

"It's not the time to stash your money into stock markets and then relax," said Brown. "You've got to be stock picking for the next one to two years."

A strong absolute return fund would also be a wise investment over the next few years, according to Brown.

"We like exposure to commodities too as we believe they're at the bottom of their cycle," added Brown. "So for an individual who can invest in something for between five and seven years, commodities could be a good bet.

"Shares in the big oil companies, such as Royal Dutch Shell, are the ones we tip. The current environment is a positive for them because as smaller oil companies come under pressure, the big companies will get opportunities to hoover up some assets. You need a balance of such shares however."

Remember however that oil prices took a further battering early last week when oil talks collapsed, so the commodity could still have further to fall.

What should I do if stock market mayhem returns?

"In a bear market or a recession, the best places to invest is in safe haven assets such as government bonds, like US treasuries, British gilts or German bunds, or to keep your money in cash," said O'Reilly. "The dollar also tends to do better during recessions than most other currencies. Bonds tend to rise in a recession and cash does not lose value. But returns are minimal at the moment due to zero interest rates, so pensions and saving accounts could lose out on a few more years of good returns."

Hedge funds could also be worth considering, according to O'Reilly, because hedge fund managers can short the market and make money from falling stock markets (as long as they make the right call).

"Within equities there is no place to hide. All stocks will lose value in a bear market, but some will fall less than others," said O'Reilly.

Cyclical stocks - that is, the shares of companies that depend on discretionary spending - tend to fare poorest in recessions as consumers and businesses cut back on spending. So shares in courier companies, and travel and home furnishing businesses for example are often first in the firing line.

Defensive stocks, such as healthcare, utilities and defence, typically fare better. They still fall in value, but not to the same extent as cyclical stocks. Some defensive stocks worth considering in a bear market include the likes of the British aerospace giant, BAE Systems; and pharma companies Roche and GlaxoSmithKline, according to O'Reilly.

The shares of high-quality blue chip companies that pay dividends (such as Vodafone and Nestle) could also be worth holding onto, or buying during a bear market, added O'Reilly.

"If markets perform badly or there is considerable volatility, the implications for investors partly depend on what causes the volatility - for example is it changes to interest rates, oil prices or terrorist attacks?" said Stan Pearson, head of European equities at Standard Life Investments.

"That given, selected banks should do quite well, such as Bank of Ireland. Financial stocks would suffer as bond yields fall lower."

Bear markets can be a good time to snap up cheap shares - particularly if you have a lot of cash and are a long-term investor. Many shrewd investors buy at the bottom of a market.

With so much uncertainty around Brexit, the Chinese economy, oil prices and the European banks, the jury is out as to whether or not we are on the verge of stock market mayhem and another global recession. Let's hope not.

Sunday Indo Business

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