We need robust markets to bring us out of the downturn, so should we listen to those who say shares are cheap, or those who predict more pain?
It takes two views to make a market. Well, actually vastly more, of course, because any market price is a balance between the multiplicity of views of the people buying and selling within it. But rarely is there quite such a sharp divergence of opinion about global share prices as there is right now.
On the one hand there is what you might call the case for the prosecution, which is that even after recent falls, share prices in the developed world are not properly discounting the probability of recession in the US, the impact that would have on the rest of the world, and most particularly the impact on company earnings. Shares, accordingly, are still too high.
The case for the defence, on the other hand, is that unless you take a really dire view of the future of the world econ-omy, shares are quite cheap. Bear markets rarely last for more than a year - the fall from 2000 was exceptional - and while we are heading into a slowdown, the markets will soon start to look across the valley to the sunlit uplands ahead.
These two views tussle all the time, with the defence side rallying and counter-attacking last week after the pretty devastating attacks of the first part of the year. But I think even the most robust defenders would acknowledge that there will be more battles in the months to come. In short, the markets are exceptionally volatile now and there is no end in sight to that.
It will be fascinating to see how this is resolved. On a long historical view, you would expect the occasional year when share prices end up lower rather than higher. Taking British data, the three and a bit years of decline from the start of 2000 to the spring of 2003 was once-in-a-generation stuff - the worst bear market since the 1970s. Now we have had five years of UK share prices being up at the end of the year - they were just up at the close of 2007, though they had come well off their peak (see left- hand graph). That long run of rises is also unusual.
So it would be quite normal were this bear market to last well into 2008 and, even if things pick up in the autumn, it would also be quite normal were the main indices to finish the year down.
This matters a lot, and not just in terms of the impact on people's pensions and savings. It matters because companies worldwide look like being weaned off debt finance in the months ahead, and having reasonable access to equity markets will enable them to pull through this cycle in better shape.
No one wants share madness; we had enough of that in the late 1990s. But the more staunch the markets, the more sustained the recovery is likely to be, and the more solid the recovery, the more the markets will regain their confidence.
In recent days there has been a range of papers about the direction of share prices, and it is impossible to do justice to all of them here. However, a few seem to me to capture the divergence of views particularly clearly. Start with the more bearish position. One key question is whether present expectations for company earnings are too high. Among those believing they are is the team at ABN Amro, who argue that the consensus forecasts, which have seen only modest downgrades, do not take into account the deterioration in the US economy, rising cost pressures and, for Europe-based companies, the stronger euro. Earnings Denial, it calls its paper.
Another, even more bearish, view comes from the boutique adviser Smithers & Co, whose latest paper is called The Case Against Holding Equities Today. The argument is that the US market is still overpriced and that analysts' estimates of earnings have not only been consistently over-optimistic but the bias in their forecasts is worse when profits are falling. …