After five-year run, stock market bull looks tired

Stock markets on the whole saw another year of gains in 2007, extending the bull run in stocks to a fifth year. However, the bull began to look tired towards the end of the year. 2008 is looking as though it is going to be a difficult year for stock investors.

According to the Morgan Stanley Capital International indices, the fifth year of the global bull market in stocks was led, among the large developed markets, by the German stock market. Japan's market lagged with a decline. The following table shows the gains among the developed markets in local currency as well as US dollar terms.

	Local currency (percent)	US dollars (percent)
USA	4.1	4.1
Japan	-11.3	-5.4
UK	3.0	4.7
Germany	19.5	32.5
France	0.0	10.9

Some of the biggest gains though were in emerging markets, including the so-called BRIC.

	Local currency (percent)	US dollars (percent)
Brazil	46.2	75.3
Russia	21.2	22.9
India	52.5	71.2
China	63.5	63.1

The gains in stock prices in 2007 mean that the Morgan Stanley Capital International World Index has doubled over the past five years in US-dollar terms, rising at a rate of 14.9 percent a year.

However, the bull market in stocks may have come to an end. Most markets ended 2007 on a weak note. In the last quarter of the year, the World Index fell 2.7 percent.

The headwinds for stocks that became evident in the latter half of 2007 are likely to persist going into 2008.

The global economy is likely to slow, partly due to past monetary policy tightening by central banks but also due to the turmoil that hit credit markets in the latter half of 2007. The United States economy in particular is expected to slow sharply towards the end of 2007 and in early 2008 -- some economists even think a recession is likely -- and pull other economies down with it.

Even as demand slows, however, inflation remains persistent in most economies, keeping business costs up and thereby putting pressure on profit margins. Corporate profits are currently expected to continue growing in 2008 but it is not unusual for profit estimates to see substantial downward revisions at the end of the business cycle.

Apart from the threat of shrinking corporate profits, the credit squeeze could also drag stock prices down directly by choking off the amount of liquidity available for stock market investments.

With the prospect for such a double-whammy, there is a real possibility that 2008 could see a bear market in stocks.

What could stave off a bear market, or at least limit the extent of price falls? The usual saviour of stock markets: interest rate cuts.

Policy interest rates peaked in 2007. In the face of the credit market turmoil, central banks have shifted their stances from tightening to easing despite persistent signs of inflation in the economy.

The Federal Reserve was the first of the major central banks to ease monetary policy, cutting interest rates by 50 basis points in September and following up with another 50 basis points of cuts over the next three months. The Bank of England and the Bank of Canada have since followed, cutting rates by 25 basis points each in December.

While the European Central Bank and the Bank of Japan have held firm on interest rates so far, they have at least shown themselves to be ready to inject liquidity into markets as and when needed to ease market turbulence.

Nevertheless, investors would do well to remember that in the wake of the bursting of the technology bubble in 2000, it took almost three years of price falls and two years of rate cuts before stock markets found a bottom.

With a mountain of mortgage and other debts accumulated over the past few years -- many expected to go bad over the coming months -- global markets could face similar difficulty shaking off the latest bout of financial stress.