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The downward drive in share prices that is now under way will, we believe, form another leg in the great bear market that is now unfolding. Trend following has become so entrenched that falling prices will bring out more sellers in a self-fulfilling cycle.
We expect the downward drives to last between four and six years in total, eventually taking the FTSE 100 index to a new low, possibly in the region of 2000. That's unthinkable today. The present decline will be over in a few weeks, to be succeeded by the usual New Year predictions of rising markets, then further declines will follow in 2008.
All through the declines, equity markets will spend most days rising, yet the overall trend will be downwards. Each downward drive in prices will be marked by a new story - or, put another way, a new set of excuses. First, inflation made the running. Then sub-prime took over as an “explanation” for events. Now the story has shifted to worries about oil, worries about the American economy and worries about the dollar. Those stories will also be forgotten just as quickly as the fight against inflation has disappeared from the news items.
Policy levers no longer work which is why the Monetary Policy Committee's base rate announcements will lose impact. When economies turn down, sooner or later theory about fighting inflation must give way to harsh reality about jobs and incomes. The Federal Reserve are cutting interest rates to fight recession. The Bank of England must eventually follow. The only issue is how much hurt will be done to the British economy in the meanwhile.
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