Shares digital

When the going is good, each time it’s supposedly different. But as history shows, each time it’s the same – the bubble always bursts. Russ Mould takes stock on a familiar crisis

As the world’s stock markets gyrate over worries about inflation, stagflation or recession, the macroeconomic optimism of early 2007 seems like years ago. Then, all the talk was of the so-called ‘Goldilocks’ economy and a new kind of economic cycle, where global growth would not blow so hot as to provoke inflation and interest rate increases, or so cold as to hit corporate earnings growth.

But those investors who believed this and piled into global equities a year ago are now nursing losses and facing not a new paradigm but a credit crisis.

They have also been given another classic example of how the words ‘This time it’s different’ are, as investment guru Sir John Templeton put it: ‘The four most dangerous words in investing.’

The technology bubble of 1998-2000 was a prime case, as arguments that we had entered a new golden era of productivity and prosperity were laid waste by the 2001-2003 tech crash and equity bear market.

More recently, arguments that growth in emerging markets will enable to world economy to keep powering ahead even if the US slows down have begun to look threadbare. Buoyed by hopes for ongoing Asian infrastructure investment, Lars Pettersson, chief executive of high-quality Swedish engineer Sandvik (SAND:ST) stated exactly a year ago: ‘I believe we are at the beginning of the beginning... Sandvik is no longer a cyclical company.’

Last November’s thumping profit warning rubbished such notions. Sandvik blamed weak demand for its woes and its shares have fallen 38% from their 2007 peak. UK engineers such as Charter (CHTR), IMI (IMI) and Cookson (CKSN), themselves lauded at the time as entering a brave new world of secular profit growth, have also seen their share prices crash back to earth since.

In sum, if something has never happened before, or a stock has never performed in a certain way before, there is probably a good reason why:

1 If an industry is making excess returns, more capital will rush into that sector, create additional supply and inevitably diminish those returns over time.

2 An exogenous shock, such as the credit crunch, destabilises the perfect environment required for everything to keep going regardless.

3 Valuation always matters. Investors were right to identify Autonomy (AU.) as a rising star when it floated in 2000. Yet even the Cambridge firm’s stellar growth could not justify the unstructured data management expert’s peak market valuation of £4.5 billion. Autonomy’s shares duly crashed from £34.27 to 77p by 2002, and have only got as far back as the £10 mark this year.

Arguments for a ‘Goldilocks’ economy had already been tried in the late 1990s. That all ended in tears, America’s 2001 recession and 30 months of frantic interest rates cuts from the Federal Reserve.

But no one learned from that either, so next time a pundit tries to tell you ‘It’s all different this time’, just point out the story of Goldilocks – and how the bears ultimately got in the way.

Sectors which are currently subject to analysts’ and executives’ mania for arguing the cycle will be different this time include mining and oil services and equipment. Both should therefore be treated with a degree of caution. Both have hugely outperformed for the past two years, both still have massive fan clubs and both have relative performance charts which are starting to look like they are running out of puff .

Shares says: Play safe, don’t chase rallies and stick to defensives.