Prologue of a crash

It was over 18 months ago that I made the following prediction:

"The US economic cycle has reached the stage where a sharp slowdown is not only inevitable but likely. While the timing of such a slowdown remains uncertain, it is likely that any investor who remains heavily exposed to equities for the next 2-3 years is unlikely to see any gains over the period."

On that day (April 9th 2007) the S&P 500 closed at 1450. The market then rose by a further 7% to close at 1550 on July 9th.

It then fell and fell and fell.

The market's most recent low point of 850 on October 27th was 40% below where it was when I made my prediction last year and 45% below the high point on July 9th.

You're welcome.

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If history were the perfect guide then we would all be justified in piling everything we own into the equity market.

Some professional investors, like Warren Buffett, believe that American companies offer the most compelling valuation at this most difficult of times.

Of course, with global equity markets so highly correlated it shouldn't really matter which one you pick; they all go in the same direction sooner or later!

Unfortunately, there is only one direction in which equity markets will be going in the foreseeable future: down. Why?

For the same reasons I predicted last year and more, namely:

1) Uncertainty about how much lower US interest rates will go;
2) Uncertainty about how deep and how long the US (and global) recession will last;
3) Uncertainty about how much further the US housing market will deteriorate.

If there is one thing that financial markets hate it is uncertainty and the longer it takes for these issues to be resolved the harder it will be to justify rising equity markets.

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Willem Buiter, former member the Bank of England's Monetery Policy Committee and London School of Economics professor was quoted in today's Financial Times as saying of people who for months have been pessimistic about the economy:

"Hindsight is useless. One has to look at the information available at the time and the arguments used at the time."

I guess it might be helpful if he read this blog and my posting 18 months ago.

Watch this space, Willem!