Much is coming our way, recovery included, we must hope

Published on Friday 20 March 2009 19:20

TRADITIONALLY, a bear market lasts between 18 and 24 months and reduces the key indices by anything up to 30 per cent from their peaks. But so far in this cycle, the FTSE All Share Index has halved. Gloom is now near total – house prices are, we are told, going to halve again and the key stock market benchmarks will follow suit. Maybe.

So where do we go from here? Bull and bear markets have two things in common: while they are underway the consensus view is that the trend is permanent, and, second, it is not. Many of those pundits who were forecasting a brave new technology world in 2000 and predicting that the oil price would reach $200 a barrel are now on about an Arctic economic chill that will last for a generation.

Of course there are serious challenges, but there are also some encouraging indicators. Economies such as India and China are growing more than 7 per cent a year – slower than before perhaps, but still at a pace that would be embraced with both hands by the West. Consider, too, the US housing market. I believe house prices are an important key to economic progress. One of the causes of the excesses of the recent past was a spike in the cost of housing, which prompted a glut of lending and, in turn, drove house prices to unsustainable levels.

Interestingly, in July last year US housing stocks had risen to 4.6 million, which triggered a sharp fall in prices. Since then, US housing stocks have fallen to 3.6 million. The housing industry in the US regards a figure of 2.6 million as a reasonable inventory. As a result, over the past eight or nine months roughly half the excess in the stock has cleared. With new-build paralysed, I understand that the pace of this decline is accelerating, so that by the autumn the overhang within the US housing market may have cleared completely, which might then provide support to the market. Interestingly, here in the UK expressions of interest in houses are starting to pick up, even if the main builders are having to discount heavily.

I believe that much of the bad news is now within the public domain. With cash as an asset class now valueless, at least as a source of revenue, consumer confidence may begin to revive.

Unfortunately, I am convinced that, two years hence, the inflationary bomb whose fuse has been lit by today's monetary laxity will detonate. Money has been pouring into corporate bonds over the past six months, which is understandable, but these are not assets that one would want when inflation takes hold again. The problem will probably not be one for the current tenant of No 10 to address but the new administration will have to look to the country's finances quickly.

This will mean some difficult decisions, including a Draconian reduction in the bloated public sector over which the current executive has presided, and the imposition of a much more orthodox monetary strategy to restore faith in sterling. In turn this will persuade overseas investment into the Treasury bonds that we shall have to sell to fund our huge deficits.

A friend recently told me of a conversation with an eminent banker, who said he had never been so depressed or pessimistic. Without wishing to add insult to injury, that is one of the most positive things I have heard for some time.

&#149 Bryan Johnston is a director of investment manager Brewin Dolphin