Given the recent increase in market volatility, the difficulties in debt markets and the approach of 19 October, there is a temptation to draw comparisons with events 20 years ago, when world stock markets collapsed, ending the strong bull run and foreshadowing the property crisis and recession of the early 1990s. But how similar to 1987 are the events of the past few months and what are markets expecting for 2008 and beyond?
There were many diverse factors which contributed to the crash in 1987. The US Federal Reserve had raised interest rates in September for the first time in three years, to restrict inflation and prop up the dollar. In the UK, the “great storm” on the previous Friday had prevented many brokers getting into London to close off their positions, resulting in nervousness over the weekend. When Monday came, the selling started in the Far East and spread west.
This summer’s correction, on the other hand, was directly attributable to a general underpricing of risk and rising defaults in the US sub-prime mortgage market, leading to losses in the financial system and uncertainty as to where these had been incurred.
Despite the ructions, markets only fell around 10 per cent in July/August this year, as opposed to the 25+ per cent falls in 1987. Furthermore, today’s markets are already back to their pre-correction levels, whereas it took until 1989 to recover from Black Monday.
In 1987, the FTSE All Share Index had also risen more rapidly than today – quadrupling since the beginning of the decade and rising 37% in the first nine months of that year. Equity valuations ahead of the crash were significantly higher than today.
As in 1987, this year’s credit crunch has foreshadowed a property slowdown: property shares have already fallen by 27% to 30 September this year. The property market is showing signs of stress and housebuilders’ shares have struggled. But the comparison with 1987 ends here. To the end of September 2007 from its low point in March 2003, the UK market has gained 108%; and the year-to-date rise was just less than 8% when sub-prime concerns began to undermine it. Meanwhile, valuations for the UK market, measured by the PE ratio, are estimated at 13.9x for December 2007, well below long-term averages.
Looking to 2008, we estimate 4% corporate earnings growth next year and a forecast dividend yield on the FTSE All Share of around 3% to produce an estimated total return of 7%, before any upside from a re-rating by the market. The argument that we are facing a re-run of 1987 is therefore a weak one, and equities remain the most attractive asset class.
Leigh Harrison is head of UK equities at Threadneedle