Market jitters indicate fears of steeper fall

THE nervousness in world stock and bond markets that has triggered sharp price falls over the past two weeks could be the prelude to a far more serious decline, according to some market analysts.

Concern is greatest in the US, where investors are still worried that a stronger than expected economic recovery may lead to higher interest rates in the near future. It was this that set off the sharp fall in the US bond market two weeks ago. And the sharpness of the downturn underlined how nervous investors have become.

Although the British and European markets have largely followed New York's lead, the prospect for further interest rate cuts looks better. 'We are hoping for a one percentage point base rate cut around Budget time, but there is still some uncertainty in the market,' said Robert Barry, UK economist at BZW.

However, many analysts and investors are becoming convinced that most leading stock markets have become dangerously overvalued. Last Friday, the current bull market in US shares became the longest this century, running 1,128 days (since the Gulf war) without a decline of more than 10 per cent.

The Dow peaked most recently on 2 November, closing at 3,697.64. Propelled by lower interest rates, share prices have hit all-time highs in the US, UK, Germany, Canada, Hong Kong and Singapore, while markets in France and Australia are only a few points away. Only Japan has resisted the trend.

In the US, industrial share prices are now trading at an average 32 times earnings, 3.2 times book value and 35 times dividends - all levels associated with previous crashes in 1987, 1962 and 1929.

While the economy in the US is finally showing real signs of recovery, with corporate profits beginning to slow the rise in the towering p/e ratios, economists note that 11 of the 16 post-war 'corrections' occurred while profits were rising.

But the rising profits are none the less encouraging investors to continue pumping money into the market when they should be getting more wary.

The consensus is that some sort of correction is due in early 1994, although guesses about what will trigger it inevitably vary widely. Elaine Garzarelli at Lehman Brothers, who is famous for accurately predicting the last crash, expects a definitive upturn in interest rates to spark a sell-off.

The pessimism will be deepened if Congress rejects the North American Free Trade Agreement in a vote on 17 November. 'Should Nafta fail, much of the enthusiasm for equities would wane quickly as investors recognised the negative consequences for growth and inflation of a protectionist majority in the USA Congress,' said David Shulman, chief equity strategist at Salomon Brothers in New York.

'You can see short-term sentiment being undermined by a vote against Nafta, because the market will see this as undermining the Gatt talks,' said Sushil Wadhwani, economist at Goldman Sachs in London.

Short-term weakness was likely in any case, he argued, because investors wanted to take their profits on shares and bonds before the year end. Any adverse piece of news would be taken as an excuse to sell.