KEY POINTS:
The big questions on many investors' minds are "How bad is it going to get?" and "When will the stockmarket stop falling?"
Certainly the trend since the world stockmarket peaked in October 2007 has been down. Some experts argued that the market bottomed decisively in November 2008 and it's onward and upward from there. But in the past few days, with bad news from Fisher & Paykel, Nuplex and PGG Wrightson, the market has dropped below the November lows.
January's gains now look like something of a dead cat bounce. In any case, stockmarkets look forward a year or so, so it's a good bet that economic conditions will get worse before they get better.
The turbulence in the market is setting all sorts of records and creating valuation anomalies. In many countries shares now pay higher income yields than bonds.
In modern times it was the received wisdom that shares should pay lower dividends than bonds because with shares you got growth as well.
Today growth looks elusive in the short and even medium term while risk is foremost in most people's mind. Everyone is thus buying bonds, sending their yields lower, and selling shares, sending their yields higher.
The worry, of course, with long bonds is that inflation will eventually kick up, interest rates will rise and bond prices fall. Or will deflation set in and short-term interest rates fall further, making long bonds more valuable? Who knows?
A friend sent me an interesting study which provides some insight as to how long it might take before we dig ourselves out of this crisis and what could happen next.
Two American academics, Kenneth Rogoff from Harvard University and Carmen Reinhart from the University of Maryland, looked at these two questions in a recent paper.
The news is not good. In their study of the aftermath of 18 severe financial crises since World War II and a couple of pre-war episodes for which they have data, the authors conclude that subsequent to a serious financial crisis, falls in the prices of key financial assets like houses and shares are prolonged and deep.
The authors say falls in house prices average 35 per cent in real terms and continue falling for an average of six years.
The 35 per cent figure is an average - house prices in Finland, Hong Kong and the Philippines during their crises managed to fall, peak to trough, by 50-60 per cent. House prices in Japan fell for 15 years in a row. Ominously, the current decline in US house prices of 28 per cent is already twice that recorded in the Great Depression.
What might this mean for New Zealand homeowners? New Zealand house prices peaked in November 2007 at $352,000 and 13 months later are down by just 7 per cent to $328,000. If the study is anything to go by, New Zealand house prices may have a lot further to fall. This will have implications for the health of the local banking system as many new home buyers start with equity in their houses of 20 per cent and under.
It doesn't bear thinking about how many families could have negative equity in their houses should prices fall by 35 per cent.
Faced with this scenario, the logical solution for governments is to inflate their way out of trouble by what is euphemistically referred to in the US as "quantitative easing" - better known as printing money.
Most experts agree that anything is better than deflation.
On a brighter note, the British experience of a few years back was that banks took quite a flexible view on negative equity.
If homeowners could continue to service their mortgages the banks usually didn't demand additional collateral.
Faced with this sort of scenario, homeowners with mortgages should probably opt for a floating rate but, perversely, hope that their interest rate goes up as this will probably be due to either a stronger economy, which is good for house prices and jobs, or inflation, which will relieve their debt burden.
Alternatively, if things get worse, mortgage rates could trend a lot lower.
The study also looked at stockmarkets and concluded that they fall by more than houses, but the time over which they fall is shorter.
Real estate agents and landlords need not feel too smug, though - while stockmarket falls were greater, at an average of 55.9 per cent, the stockmarket returns are for companies with debt.
Companies have debt, therefore the impact on their profits, and thus share prices, of a recession is greater.
But the data for house prices assumes no borrowings, which we know doesn't reflect reality, so the true impact of the average 35 per cent fall in house prices on the equity invested will be much higher.
For example, a fall in house prices of 33 per cent translates into a 66 per cent reduction in equity, assuming 50 per cent gearing.
The average downturn phase for sharemarkets lasts 3.4 years, so if the decline in the world stockmarket started in November 2007 we may have another couple of years of pain to endure.
However, the world stockmarket in US dollar terms is already off by 48 per cent in nominal terms and with the average fall 55.9 per cent some sensible people are saying the worst is over.
In the crash of 1929, the decline in the New Zealand stockmarket was relatively restrained, falling, peak to trough, by just 38 per cent from its high in August 1929 to its low in April 1932.
As far as the current crisis is concerned New Zealand has done relatively well - down 33 per cent since its peak in February 2008.
The worst-performing stockmarket of the 20 banking crises analysed was Iceland's 2007 meltdown, when its stockmarket fell by just over 90 per cent.
All very depressing. But on a lighter note, this is an appropriate time to test readers' general knowledge of matters Icelandic: What is the capital of Iceland? About 25 cents.
* Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.
