Share price wobble gives warning

Submitted by Matthew on 14 February, 2018 - 8:40 Author: Rhodri Evans

As Solidarity goes to press on 13 February, the Dow Jones and S&P 500 share price indices in New York have been recovering since 8 February, though they are still at a lower level than when they suddenly dipped on 1 February. The FTSE 100 index in London, the DAX index in Frankfurt, and the CAC 40 index in Paris, have all been recovering since 9 February, but are lower than their recent highs on 29 January, 23 January, and 26 January respectively.

So far, the early February downturn looks like a limited wobble in a pattern of rising share prices since 2009. The S&P 500 has risen from an index value of 683 in 2009 to 2873 in late January 2018: if you had shares worth $1000 in 2009, by late January 2018 you could sell them for $4204. The “price-earnings ratio” for FTSE 100 shares, that is, the average share price per £1 annual corporate profits, is currently around 29, way higher than the average over the last 14 years, which is 12.6. The wealthy have believed that profits will rise, and so bought shares, and bid up share prices, on that assumption.

Government bonds have been paying low returns, so more of the wealthy have preferred to buy shares instead. A trigger for the recent wobble has been that the US Federal Reserve pushing up its interest rates and making it clear that it will push up those rates further, thus promising better returns on bonds. But wobbles can turn into crashes. Sooner or later, they surely will. Once the wealthy see profits sagging, they sell off shares, and the price-earnings ratio crashes down to its norm, or below. The effect is quicker and more drastic in particular sectors.

We recently reported in Solidarity on an Oxford finance professor’s take on the “private equity” industry, which works by borrowing money cheap, buying up firms’ shares, remodelling the firms by slash-and-burn to boost profits, and then selling shares again at a higher price.

“A cataclysm is bound to happen. The combination of overpricing and high leverage [debt] cannot lead to anything other than a lot of defaults... It is quite amazing that there is no collective memory that goes beyond five years, or that the world is organised in such a way that history keeps on repeating”.

No public control over high finance has been established since 2008 to stop that repetition.