The stock market: how bad can it get?

Share prices have fallen by a fifth since their peak a year ago, and the majority of City analysts believe worse is still to come. By Nick Clark

The roar of the bear is shaking the London stock market once again. The FTSE 100 Index of leading shares fell as low as 5,358 yesterday morning, taking the total loss since last June's peak of 6,732 to a shade over 20 per cent – the technical definition of a bear market.

Although the blue-chip index recovered later in the day, City analysts believe the respite is almost certain to be temporary, with no prospect of interest rate cuts to boost the economy while domestic inflation fears remain and global commodity prices continue to soar. The bear has not been sighted in Britain since 2002, although the US moved into bear market territory some weeks ago. Our jury of economists, fund managers and stockbrokers is almost unananimous: he's back and he's only just beginning to sharpen his claws.

Tom Elliott, Strategist, JP Morgan Asset Management

The situation is liable to get worse for the broad economy in 2008. The full-year estimates of GDP growth imply a significant slowdown in the second half of the year. The declines will be driven by a slowdown of spending in the consumer sector, which makes up 70 per cent of GDP in the UK. Food and fuel costs and mortgage payments are rising while house prises are falling. This will probably lead to people increasingly looking to save and trying to de-lever their housing debt. Discretionary spending stocks have suffered, while traditionally defensive ones are up. It is nice to see the market working as it should.

On the plus side, we think inflation fears are overdone, as there has not been much of a rise where it matters – wages. Wage growth is slowing, which should help, and means the Bank of England might not lift interest rates.

Jean-Michel Six, Chief economist, Standard and Poor's

It is challenging to detect bright spots in the current market. We are in the eye of the storm and the summer will only be tougher. There was hope that the Bear Stearns rescue would signal that the worst of the credit crunch was behind us, but we are only beginning to see it move into the real economy. The second half of the year will probably be much gloomier than the first. It looks as if consumers are being overwhelmed by falling markets, rising costs and stagnating incomes.

This will last at least until the start of 2009 as the risk of a consumer-led recession remains very much present in the UK, driven by the housing market downturn. One light at the end of the tunnel – although it is very long tunnel – is the possibility that oil prices might ease in the fourth quarter, especially if the dollar strengthens. While there are structural reasons that it is so expensive, cyclical factors could see it drop $20 a barrel.

Philip Shaw, Chief economist, Investec

There are likely to be further falls before the end of the year. The market is taking far too bullish a view on domestic cyclical stocks like general and food retailers, and the leisure sector – basically, all those dependent on consumer spending. Resource stocks are also looking well overvalued. Whether we are in a technical bear market or not, the falls we have seen this year are still worryingly large.

The UK economy is pretty close to recession, and there is a 50:50 chance of it hitting a technical recession by the end of the year. So far, the market hasn't been factoring in that possibility, but if it does happen there will be further falls to come.

Ian Stewart, Director, Deloitte

What is clearly happening is that problems in the banking sector are being increasingly transmitted to companies because the supply of credit is tighter and interest rates are higher. Banks are searching for liquidity and looking to offload their debts. That has translated into a hit on the corporate sector, especially the consumer-facing groups.

The wider economy is slowing, while inflation is rising and the potential for higher interest rates is real. The brief rally in May has now played out. Historically, asset bubbles take a long time to deflate, they don't actually burst overnight. Judging by that, the signs aren't great.

Khuram Chaudhry, Quantitative strategist, Merrill Lynch

Fundamentally, I am quite negative on the economy and the direction of the stock market. Although there will be some bounces along the way, there won't be the return of a bull market any time soon. The key is to enter back into the market when sentiment becomes depressed; it appears there could be some lift in the near future. I can see a near-term bounce as company directors have increased share-buying. It is quite a good indicator.

As the fears of rising inflation have grown, the market became more complacent about the downside risks of growth. Now investors are starting to address those risks. Still, this is not a good situation. Growth is slowing, inflation is rising and profit expectations are falling, which will have an adverse effect on the stock markets. However, the real global risks are coming next year. Analysts' estimates for 2009 appear too high, because Asia and the emerging markets will begin to slow more rapidly, having a knock-on effect in Europe.

Roger Bootle, Chief economist, Capital Economics

I suspect the market will remain rather weak and will get worse towards the end of the year. The market hasn't yet factored in the seriousness of the situation it faces, with weakness in the retailers, banks and housebuilders. It will remain subdued for a year or two. Next year will be the worst, but there should be the start of a slow recovery by 2010.

Howard Archer, Chief economist, Global Insight

We are cutting our growth forecasts further, and we now have the British economy on a "stagnant" rating. Consumer spending is slowing. In the first quarter of the year the numbers were resilient and then there was a rise in May, which was a surprise. There is likely to be a correction in June, as consumers reign in their spending this year.

It also looks as if many companies are cutting back on their investment plans. This is not surprising as credit conditions tighten and the outlook weakens. There were hopes that the weakening pound might help make exports more competitive but, at the same time, demand from the key markets in the US and the eurozone is falling. It is hard to see where growth is going to come from.