Beware green shoots: the bears will still beat the bulls

THE fragility of the “green shoots” recovery theory that has seen the FTSE 100 rise almost 30 per cent since its 9 March low, came to a shuddering halt last week as it lost 2.6 per cent, breaking its five-week winning streak.

The blue chip index is now stuck in the middle of a tug of war between the bulls and the bears over which way the index is heading and whether the green shoots will grow or wilt.

So far, the green shoot brigade appears to be winning with some heavyweight support. The National Institute of Economic and Social Research said the economy may have stopped sliding in April for the first time in a year. Meanwhile, Credit Suisse is predicting UK growth of 1.8 per cent next year, up from one per cent, and JP Morgan has also revised its forecasts up, predicting that the economy will contract by 3.6 per cent this year, up from a previous estimate of four per cent.

And even staunch bears such as Citigroup’s Michael Saunders are adjusting their forecasts upwards. Saunders now expects the UK economy to decline by 3.9 per cent this year, from 4.1 per cent a month ago. And instead of a 0.7 per cent fall next year, he now predicts slight growth of 0.1 per cent.

But some heavyweights are backing the bears too, including Bank of England governor (BoE) Mervyn King, who last Wednesday knocked an impressive 100 points off the FTSE, after he forecast a “long bottom” in his Inflation Report.

But having been continually criticised for his inability to spot and respond soon enough to the financial crisis we are still embroiled in, it’s in King’s interest, this time at least, to bat for the bears.

But there are some other reasons to believe that the bears, while their numbers are admittedly dwindling, will ultimately prove the winners in this particular tug of war.

Firstly, history shows that recessions triggered by financial crises tend to be deeper and last longer than those caused by other shocks. Secondly, all the evidence of an improvement in economic recovery is coming from a low base and generally the economy, such as unemployment, for example, is still getting worse simply at a slower pace.

Third, policymakers have thrown everything they have at the crisis, and cannot afford to do much more. In fact, as soon as things do genuinely improve, they will have to act fast to put policy back on a more normal footing again. The BoE will have to hike interest rates up rapidly from their current historic low of 0.5 per cent, for example, and the government will have to dramatically curtail public spending.

The bears are still set to win this battle. This rally won’t last and if you missed out this time round, now is not the time to get involved. With the equity market apparently taking a breather before what is likely to be fresh falls, investors would be wise to follow suit.