In this article from The IRS Report published in September 2010, John Snowden discusses the latest market changes...

Double dips - a sour taste for markets

I have not commented on the V or W factor for a little time. The other day I opened a magazine from January this year where I saw the words: "A Government minister said today that she could see a few "green shoots" of economic recovery". This was Business Minister Shriti Vadera who added that it was too early to say how they would develop and made clear that she was not predicting the end of the current downturn.

These words may have been in support of Chancellor Alistair Darling's forecast in his Pre-Budget speech in November 2009 when he forecast a return to growth by mid-2010. At the time Vince Cable, the current Business Secretary, labelled these comments "a work of fiction".

So, where are we now? The FTSE 100 Index dipped below 5,000 at the turn of the month of June/July. All the signs were pointing lower to complete the second part of the W, yet by the end of the month the index had revived with a gain of over 11%. Most of the European markets followed suit, recently hitting three-month highs.

The UK banking figures released in early August helped the UK momentum but the Footsie once again failed to move into higher ground. The banking figures were reported as "solid" which is perhaps unsurprising as they continue to dribble out loans while focusing on rebuilding and strengthening their own balance sheets.

With the historically low base rate of 0.5% and lending rates of 18% plus, it would be extremely surprising if banks were not making substantial profits. In the old days, a banker would be delighted with a 6% margin, now they are lending on margins we used to associate with pawnbrokers.

Another major event is that the Chinese economy has overtaken the leaden-footed Japan into the number two slow. Look back at Japan over the last decade and it may well reflect the coming decade in the UK.

More important is that the USA remains at the top and most important is the divergence between Wall Street and Main Street. This has become quite scary as consumers remain at home and keep their hands in their pockets. Remember we in UK always follow the US and if the Street loses its smile as the previous waves of fiscal stimulus begin to run out, we will be in for a long hard winter.

I always keep an eye on what Warren Buffett, the Sage of Omaha, and his right hand man Charlie Munger, otherwise know as the Two Ronnies of American capitalism, are up to.

Buffett and his company Berkshire Hathaway have an enviable track record, but copycat investors may well come unstuck these days as his greatest deals were made when the company was smaller - as were the deals. Recently he pulled off mega-deals such as stakes in Goldman Sachs in 2008 or his recent bid for Burlington Northern Santa Fe Corp railroad operator. You cannot follow into this stock as the $34bn offered is a bid for the entire company. Anything he does receives immediate media coverage - such as buying a stake in Tesco. But his latest move, to rebalance his multi-billion fixed income portfolio into shorter dated bonds to protect it from inflation, is one we can all draw lessons from.

This move seems to make little sense as the current talk in the US is of deflation or possible deflation. However Buffett always takes a longer-term view and in recent years he has expressed fears that the money created by governments in the great bail-out will eventually fuel inflation.

Investing in shorter bonds will make the Berkshire Hathaway portfolio less sensitive to interest rate changes and price movements. Perhaps Buffett is making this move now rather than later as he believes we will have a double dip with a vengeance, resulting in more turbulance and crises. His strategy may be to invest in short-term protection but if he does fear meltdown he could not say so as this might cause a collapse in US stock markets and would certainly make confidence evaporate.

If the master believes worse is round the corner, the W may stretch itself a little before the second downturn actually happens, but the analysts and investment banks are constant bulls, as they have to be to sustain their business. They appear incapable of differentiating between profits gained by cutting costs and those derived from producing and selling more or creating better products - the former are unsustainable, which is why earnings forecasts for next year may soon start to be slashed. I remain bearish on the big economic picture.

You can see all of John Snowden's articles at www.TheIRSReport.com

John Snowden is a regular contributor to The IRS Report.

Call 0800 756 5437 or click here for more information.