After the fall of the past week or so in global stockmarkets there is now no doubt about it - the grinding "correction" in share prices over the summer of 1998 has matured into a fully fledged bear market.
Many investors must be wondering why current circumstances have acted to create a bear market whereas the falls in stockmarkets in previous corrections proved to be shallow and short-lived.
For example, in the autumn of last year global stockmarkets fell when the Asian crisis first emerged, but then they quickly recovered.
A large part of the explanation as to why this correction has become a bear market is simply the longevity of the bull market. Share prices throughout the globe (excluding Asia) have been rising continuously since 1992 and had got to levels considered to be overvalued by many commentators.
However, complacency reigned supreme in the market with many pointing to a new paradigm of sustained low inflation, improved productivity and steady economic growth. Although no one believed that the economic cycle was dead there were many who argued that the nature of the economic cycle had fundamentally changed for the better.
At the root of the current weakness in global stockmarkets is that investors are waking up to the fact that the economic cycle is still alive and well. Furthermore, the recent moves in bond markets imply that investors are now beginning to take the view that world economic growth will slow quite sharply in 1999 and possibly into the new millennium.
The catalyst for this sharp turnaround in sentiment has undoubtedly been the financial, political and economic crisis in Russia combined with the seemingly interminable problems of Asia. On their own even a severe recession in these economies would not be enough to bring the world into recession. It's worth bearing in mind that Russia only represents less than 1 per cent of global GDP and its direct economic impact on the Western economies is negligible.
Japan, the Pacific Rim, Russia and Latin America together represent about 25 per cent of global GDP. A recession in all of these economies would seriously dent world economic growth but would not be enough to create a global recession. However, the extent of the recent weakness in share prices suggests that investors are worried about an economic slowdown in the US and Europe.
Although the US economy has continued to grow strongly so far this year there are signs that the pace of growth is slowing. Also there will be fears that the stockmarket correction itself will depress consumer demand. Share ownership is widespread in the US so that the negative wealth effect induced by falling share prices could well depress consumer sentiment. If the US consumer were to significantly reduce spending, that on its own could trigger a recession in the US.
In Europe (excluding Britain) overall economic growth has been improving. Very rapid growth in the peripheral economies combined with a strengthening economic outlook in the core of Germany and France has resulted in optimism regarding the initial period of monetary union.
However, even before the crisis in Russia there were signs of some faltering in the pace of German growth. The German economy does have some direct exposure to Russia so that the deteriorating Russia situation will have some negative impact on German growth. In response to weakening sentiment regarding the German economic outlook the view had taken hold that German interest rates would remain at current low levels. Furthermore, the new monetary union is expected to start life at German interest rates rather that at the current (higher) average interest rate of founding members. Given current uncertainties the possibility of a reduction in German interest rates cannot be ruled out.
Uncertainty regarding the outlook for economic growth and corporate profits is the key factor behind current stockmarket weakness. As it will take at least a number of months for the 1999 economic panorama to come into view as current unsettled conditions are likely to persist for quite some time. Although current share prices do not represent exceptional value, relative to deposit rates and bond yields shares are now beginning to look very attractive.
In particular the Irish stockmarket now offers very good value given the strength of corporate results. During the week CRH followed in the footsteps of AIB by announcing better than expected results. Strong growth in Irish corporate profits sets the Irish market apart from many of its international peers. The prospective drop in short-term interest rates to around 4 per cent and a strong domestic economy has not been sufficient to protect the Irish market from the waves of negative international sentiment.
However, once the dust settles there could be some very attractive investment opportunities for those prepared to take the long-term view.
