Saturday, 1 November 2008

XAO Has Worst Month Since October 1987

Firslty to the person who voted for a decline of ten percent or more in October in last months poll, stand up and take a bow. After a fall of more than eleven percent in September the All Ords plunged -14.0% in October to record it's worst month since October 1987. Interestingly of the 5 worst months in the last 25 years, 3 of them have occured in 2008 and 3 of them occurred in the month of October.

The glass half full persepctive might say that with 3 of the worst months in the last 25 years occuring in 2008, the odds of another horrible month are very low. The glass half empty might say that it indicates just how bad this financial crisis/recession is.

Another persepective that I subscribe to, would say that it doesn't mean much at all for what lies in the future. A theme that I have been harping on for some time and has been heavily influenced by the author of the Black Swan, Nicholas Nassim Taleb, is that, in an ever increasingly and complex world we are going to continue to have large volatile events of increasing frequency.

Take one measure of stockmarket volatility, the VIX. The VIX averaged about 60 during the month of Ocober, it has never averaged more than 45...ever. We have unprecedented meddling by governments in financial markets, what will be the unintended consequences? We have the most complex and global financial system ever that contain the most arcane financial instruments ever created. We have seen some of the consequences of that.

Any objective measure of how the US Federal Reserve and Treasury have handled the current crisis would have to say they have made some blunders. However the consensus view is that they have finally got it right and that things will turn out fine. Yes 4Q08 will be bad, estimates of a contraction in US GDP of about -3% are now common. Unemployment will continue to rise, house prices will continue to fall and corporate earnings will continue to disappoint.

However, that is apparently already discounted in stocks, just like it was in January, in March and in July. Sure stock prices look much more attractive than they did 12 months ago but the idea that they reflect all the risks going forward I find dubious at best.

So what for November? Whilst October was the worst month since 1987, the last week of October was one of the best weeks for stocks in some time. Can that momentum carry over into November? All signs seem to say yes. Credit spreads have come in, the VIX has come down, some of the Federal Reserve programs have begun to kick in and markets are focussing on boring econmic data rather the spectre of financial meltdown.

However, I get suspicious when others are get comfortable, I don't know what the new 'normal' is but I do know it is not going to be the same as the normal that has prevailed for the last few decades. This is not a contrary call for the sake of being a contrarian but rather a recognition of the uncertainty that remains going forward.

Once again I have no strong views about short term market direction. I would certainly not be surprised to see the market continue to rally in November but I am going to stick my neck out and say that the market will finish lower in November for no particular reason.

Also don't forget to have your say in this month's poll.