Apocalypse Deferred

I hate to say I told you so, but I did rather tell you so. At the start of last week I suggested here that there were reasons to worry about stock markets, and the financial system generally. At that time the FTSE 100 Index, the generally used measure, was at about 6,527. Last night it closed at about 6,212.

A fall of about five per cent in ten working days does not take us into Wall Street Crash territory, but it does suggest plenty of others shared my concerns. The past few days have seen something close to panic. Not that panic is unusual on the markets.

The way stock markets work is that people who suspect their shares are overvalued continue to hold them anyway. This is because they are afraid that, if they sell too early, they will miss out on further rises. They then dump them in an insane scramble when bad news comes along. This is what drives markets. Fear and greed.

I suggested that shares were being held up because people were forced to invest there for any kind of income, there being no ways of generating a return on your savings anywhere else. Meanwhile, there were signs that sophisticated investors, the big banks and other financial institutions, were so disenchanted with the geopolitical/global economic situation that they were preferring to stuff their cash into safe havens, government bonds, even if these were actually losing them money year on year.

What has happened is that most of the negative factors known then have got worse. Ebola, worse. IS and the Middle East, worse. The US economy,  worse. The eurozone, worse, with the three biggest economies, Germany, France and Italy, all apparently going into reverse, for different reasons.

The falling oil price, which is at a level that would have been astonishing a month ago, should be good news, if we as consumers and our basic industries have to pay less for fuel. Except that the price is falling, despite international tensions that would normally force it up, because of global economic weakness, particularly in China.

The other day the UK inflation figures came in well below what was expected. Again, this would once have been good news. Now it is seen as a negative, because it suggests our economy is stagnating.

I suspect the markets will stabilise at around this level, if a little lower. But it leaves an awful lot of clever and highly paid City analysts, many of whom saw that FTSE 100 figure at 7,200 or 7,400 by the end of this year, looking very silly indeed.

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Irrational Markets

These are very odd markets. The abrupt falls in share prices this year could be the usual typical January and February declines after the year end surge, or they may be about to make those forecasts, widespread, that the FTSE-100 will hit 7,500 by the end of 2014 look rather silly.

I was talking to the head of a large UK company with much of its business in the US, who spends a lot of time there. He made an interesting point. US shares are valued even higher than the London market, to the extent that US investors are running scared. They know those valuations don’t make sense.

They are equally spooked by emerging markets, for obvious reasons. They are looking towards Europe for value. His share price tends to react favourably in the afternoon, London time, as US investors come in.

This suggests two things to me. UK shares may continue to see some support from US buyers seeking what they perceive as value. Until interest rates start to rise, quantitative easing tapers off further and bond yields return to “normal” levels.

Then that support may evaporate. And as we know, when such reverses take place, they take place very quickly indeed, and the effects can be alarming.

Royal Mail

Evan Davies was on Radio 4 this morning literally gibbering over the suggestion that Royal Mail shares were not actually sold off too cheap three months ago. Davies is an intelligent man and he knows how markets work.

It is near impossible to work out, ahead of any stock market flotation, how much the shares are worth. You can use various metrics. I looked at Royal Mail shares and decided the yield on the shares, and an income of five quid or so for every hundred you put in, was reason enough to buy them. Neither I nor anyone else thought they would end up where they are today. Don’t let anyone tell you they did.

The reason we have markets is to find out how much things are worth. If the value of every asset was immediately and utterly transparent, there would be no point in having a market at all. Davies knows this.

Markets are also inefficient, which is how people make money out of them, and how people like me make a living, spotting where the market has got it wrong. If markets were utterly efficient, there would again be no reason to have them.

The City did not conspire in a quiet corner to persuade the Government to offload Royal Mail shares cheap, to make a killing. Brokers could genuinely not see how the shares were worth a lot more than three quid.

There are plenty of examples when the City has got it wrong the other way, shares have been overvalued and investors have got stuffed. One company called Promethean World, where they have lost almost all the money they put in several years ago, comes to mind.

One of the reasons for the City’s nervousness is that previous attempts to sell the Mail had failed. Another, more important, is that the unions were limbering up for industrial action, as they have every right to do, and the Mail has a bad record for industrial relations.

A strike would have been hugely damaging. Several months of lost revenues would have put the shares into a tailspin. A serious strike might even have put that dividend income at risk.

If you want to know why Royal Mail shares were sold “too cheap”, you might care to consider the actions of the trade unions in the run up to that sale. And ask them a few searching questions, Evan.

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