ArabianMoney.Net

An old college friend just wrote and asked me where I thought share prices were going. To my mind it is a clear bear market and stocks have far further to fall – at least back to the 2003 lows of 7,000 for the DJI and 3,300 for the FTSE.

The $700 billion US bailout has not gone down particularly well today in Asia and Europe. But in Europe we have the nationalization of Fortis, a bailout for Hypo Bank and the nationalization of Bradford & Bingley. I just read that each UK tax payer is now holding around $10,000 of toxic debt after saving B&B and Northern Rock.

None of this makes pleasant reading and just has to be a backdrop to a major recession. The credit crunch alone as a result of these nationalizations is already going to produce a recession. It is much harder to get a loan to buy things, so things will not be bought.

Consequences, consequences

What we have yet to see are the repercussions in terms of job losses, bankruptcies and consumer spending. It is a vicious downward spiral and when people talk about a recovery in the second half of 2009 you have to ask: why? Surely this fall-out will produce another round of bad debts, write offs at the banks and restricted credit.

So while the $700 billion bailout fills a hole, it does not get us back to business as normal. It is hard to know what would do that, except a long recession and a big shake-out of every business and bank that has not got a rock solid business model.

In this case profits are going to tumble across the board. That means the cheapness of price-to-earnings ratios in global stock markets are a mirage and highly deceptive to value investors. Try inputing a loss rather than a profit on a few stocks and see what kind of a p/e ratio you get!

As George Bush said of the US legislative process this week ‘this is not going to be pretty’. Many former lynch pins of the global economy, like the hedge funds are going to collapse. Nine out of ten hedge funds do not make enough to trigger their profit shares now, and subscribers are bailing out all over the world.

Hedge fund failures

I also doubt very much that we have seen the end of problems in the global financial system. As more and more financial institutions get into tougher trading there are going to be business failures led by the hedge funds and as their inter-linked derivative products come under pressure the whole shadow banking complex may collapse. Estimates for that bailout start at $5 trillion.

This is all going to be highly inflationary and very bad for the US dollar whose devaluation will resume just as soon as the reality of the inadequacy of today’s bailout becomes apparent. You will not see the Chinese racing to buy US assets in this environment but then China’s domestic stock market is down 67 per cent and its $1.3 trillion in foreign reserves is just a drop in the derivatives ocean.

We will eventually hit a real bottom in global stock markets – perhaps around the levels I have indicated or a little lower. By then gold will be $2,000 an ounce or more and silver $60-70. Precious metals will be the best performing asset class by far in a sea of red ink. I think this will all take 18-24 months. But it could come very much quicker with a stock market crash as early as next month.