Tuesday, September 9, 2008

The Market Upsurge in Sentiment Will not Last

Note added later:

I have just taken a quick look at the new newspaper editions for today, and see that the first fall has occurred on Wall Street. Whilst thinking the bounce could not last, this was not what I had in mind. I am more than a little surprised at the fragility, but sentiment is a hard thing to get to grips with. I had in mind a month or so of optimism. As such, in this case, both right and wrong.

Original post continues...

I wrote a post just a couple of days ago regarding the bail out of Fannie Mae and Freddie Mac. One of the points that I made was that there may be a brief 'bounce' in confidence, but that it would not last. Having just briefly looked through the economics news over the last few days I am even more convinced that the bounce will be very brief indeed. It is not possible for sentiment to trump the reality of the dire situation, and the speed of the economic fall will keep momentum despite the brief rise in sentiment. For those new to the blog I suggest you read my essay 'A Funny View of Wealth' for why there is a problem in the UK economy and read here for the world economy.

Moving on to the news, a poll from Manpower suggests that job prospects are very weak indeed and, unsurprisingly, the sectors that look especially weak are construction, retail and business services. Just as a note, I have never (I believe) explicitly said that the construction sector would see high unemployment, but I hope that this has always been taken as implicit in my prediction of a house price crash. As before, I would like to emphasise that the slowdown in employment is not showing up fully in the unemployment figures yet due to the return home of many migrant Central European workers. In other words, the economy is slowing down more than headline unemployment suggests. This needs to be taken into consideration when thinking of government finance, as the drop in the level of overall economic activity will be much greater than unemployment suggests, meaning that government finances are probably deteriorating very fast at this stage.

It is also worth mentioning that, in sectors such as construction, and also financial services, there will be a delay before the workers appear as unemployed (e.g. self-employed sub-contractors). As such the downturn in activity will see a lag in the rise in unemployment. My best guess is that this month or next there will be a sudden upturn in the increase in unemployment, as the first tranche of these kind of workers appear in the figures.

In other recent news, the CEO of Nationwide (or MD? - sorry I have no link for this as I saw a TV news report), commented that he thought house prices would drop by 25% from their peak. This is a surprising admission, but in the current climate my guess is that the aim is to dampen expectations of more dramatic falls. As I explained in my essay a long time ago, the minimum drop will be 50% from the peak, but I also believe that they will 'overshoot' this level. In another article it is reported that deposits for securing a property for first time buyers have been increasing. No doubt, in some quarters, this will be blamed on the magical beastie called the 'credit crunch', but the reality is that a higher deposit requirement is a logical precaution in a falling market. The problem is that such deposits will not be sufficient to protect the banks, and the realisation of this reality will see ever more tightening of lending criterai, leading to a further downward spiral of house prices.

On a more positive note, the price of oil continues to decline, much as I predicted previously. I predicted $60-70 per barrel within two years, but the decline in price is much faster than I expected. One point of note on this subject is to question for how much longer the Gulf states will continue to peg to the $US. I am not sure that this will last out the coming storm, in which case my prediction for oil prices may suffer from devaluation of the $US against Gulf state currencies. However, if this is not the case, then my prediction stands and appears to be confirmed by the current trend. I am not sure whether it was here or elsewhere, but I have also commented that the price will probably start to rise in about 3-4 years time. I base this on the principle that the rise in demand from emerging economies will continue, and will eventually overtake the decline in demand from the OECD economies.

There is, of course, one problem with predicting oil prices, and that is the Opec cartel. My own view is that, with the parlous state of the world economy, they will not use their power to restrict supply. To do so would accelerate the economic downturn and probably leave them worse off in the long term. However, people do make strange and irrational decisions, so there is always the possibility that they will seek to constrain supply to raise prices.

One interesting indicator of the bad state of affairs in the world economy is the price of gold. As you are all probably aware, gold prices can rise as gold is a flight to safety in periods of turmoil. This is exactly what has been happening. It is worth noting though, that gold dropped abck yesterday, probably due to the short term boost in confidence arising from the bailout (nationalisation) of Freddie Mac and Fannie Mae. A part of me says that gold will continue to rise in value in the future, but another part of me is cautious, as gold has already climbed so far. However, if traditional behaviour with gold is followed, there is no reason why it will not continue to climb in value. It is a very curious thing that gold is so valued but, just like currencies, the value is built upon confidence. (or in this case lack of confidence in other assets, combined with confidence in something with a physical instantiation).

On reflection, I have jumped around a little in this post, so apologies for this. However, in light of the sudden lift in confidence, I thought I better inocculate any readers who were being infected by the rise in optimism. As I have said, it will be no more than a bounce. The real world will continue to intrude on the outlook of the sunny optimists, and it is just a question of waiting for when market sentiment will actually turn back to gloom.

My apologies for such a negative point of view, but I always intended to write about the way the world is, not the way we would all like it to be.

1 comment:

  1. Hey, thanks for this update.

    I still can't get my head round the fact that so many people; journalists, politicians, economists are so deluded. Or are they in the know and just trying to hide it?

    I have friends who studied Business or Economics who have bought houses in the past two years. Who always laughed at me when I said the prices were unsustainable.

    I have a friend who recently started working at one of the investment banks in the city and he is continually surprised at the bad news coming out.

    I really don't get it. What are they taught at Uni?

    I wrote here a few weeks ago as ‘Anon’ saying that I was thinking about leaving the UK. I’m definitely going now, just not sure where yet. I’m originally from the Netherlands but am not really in the mood to go back there. I always wanted to go to China or Japan… but you weren’t confident about their predicament either. Well I still have 6 to 8 months to decide and save (crappy £'s)


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