There's a probability you didn't receive our February Letter from Linlithgow. I had written it in the few days after I survived my 60th birthday party. It was supposed to be sent out to clients before the end of February, obviously, and some were. Bearing in mind by then the stockmarket corrections had started, I felt it was inappropriate to send the remainder. However, the February Issue is posted on our website if you would like to read it.

The message contained within it was the overvaluation of property and the undervaluation, even then, of world equities. If large cap world equities were cheap before 1 March they're even better value now, if you believe this is a buying opportunity, as opposed to the end of the World. The other day I received interesting research from the US from economists at First State Advisers and I thought I should share it with you.

Their report stated "Real GDP growth has fallen below 3%, the unemployment rate is way down from the recession highs but seems to have stalled, initial claims have spiked, and productivity growth has slowed. Recent average hourly earnings are still lower than they were at the peak of the last recovery, and the ISM Manufacturing Index has recently dipped below 50 - it's lowest level in almost 5 years. Despite a 5 year old recovery, manufacturing payrolls are shrinking. Demand is weakening among consumers and businesses. Retail sales excluding autos are up only 2.5% versus a year ago and shipments of capital goods excluding defence and aircraft are up only 1.6%. Given these worrisome economic statistics, how can we remain optimistic? How can we remain confident the expansion will continue?"

"Because the data referred to above is purposely misleading. It sounds familiar but none of it is from the current recovery. It's data from January 1996. That's right - 1996 - right smack dab in the middle of the last expansion. It comes from what has been called a growth recession in the mid 1990s, just before productivity growth accelerated and economic growth picked up again."

Interestingly enough the similarities between the two business cycles are striking. Both started off with modest recessions, followed up supposedly weak jobless recoveries. After dramatic Federal Reserve tightening the US economy entered a soft patch. Then in the mid 1990s the economy accelerated and falling unemployment helped to generate strong income gains for all workers across the income spectrum. As a result the US Government found itself on the receiving end of a gusher of taxation revenue that drove the Federal Budget into surplus territory for the first time in decades.

It's expected this pattern will repeat itself in the current decade. Not every monthly or quarterly bad data signals the end of an economic expansion. Sometimes it's just statistical noise. It's normal for data to be revised later but when that happens it turns out the soft spot never even happened in the first place. It was just bad data based on limited information and faulty statistics. The probability from here is robust economic growth and healthy stockmarkets.

The latest correction has probably been caused by a brand new fear that very few of us will have even come across before - sub-prime mortgages! It would be helpful if you got some perspective on this, and then perhaps you'll see why we're still confident for the next two to three years. Firstly, what's a sub-prime mortgage? It's a loan granted by a lender to a family who really can't afford it. It's a high risk loan, in other words.

There are 114 million households in the US that own homes. 50% have no mortgage at all. Let's pretend for a moment that one-third of the remaining 50% are financed by sub-prime mortgages. Please note this is not even close to reality. I'm merely stressing a point of how ridiculous the panic has become.

So that would be 33% of 50% of 114 million which comes to 18.8 million households.

It was reported the other day that 4.53% of all sub-prime mortgages were in default - up from 3.33% a year ago. It is claimed this number is expected to rise. For the purposes of this exercise let's assume another worst case - though highly unlikely - let's assume the default rate goes to 9%. Actually let's make it easier on ourselves and make it a flat 10% and also assume not only does the mortgage default, but the value of the mortgage goes down to zero.

Now let's go back to the 18.8 million. Take 10% of it. Assuming the worst case scenario that dwarfs pessimists' worst assumptions, we would have 1.88 million households in the US walking away from sub-prime mortgages, and then see the value of their mortgage fall to zero. That looks terrible doesn't it? Or is it?

1.88 million households is roughly 1.6% of all US households, which means 98.4% of households are going to be OK. And that's a worse case scenario! So where's the problem?

As usual a new new fear has come along, panic is overdone, and stockmarkets fall.

All sentiment indices we track have triggered extreme pessimism, not seen, in some cases, for more than 20 years. The probability is this is a buying opportunity. It could be the best single occasion to buy stockmarkets since March 2003.


Alan Steel


This letter is the personal view of Alan Steel. Please check the appropriateness to your individual position with your adviser before taking or refraining from any action.

Alan Steel
Alan Steel Asset Management Ltd is authorised and regulated by the Financial Conduct Authority

The Financial Conduct Authority does not regulate tax advice

This article is the personal view of Alan Steel. Please check the appropriateness to your individual position with your adviser before taking or refraining from any action.