These jitters could last for years

THE tumbling stock market may be unnerving investors but it is no surprise to City professionals and economists. They may not have been expecting this week's falls to be quite as dramatic as they have turned out, but they have suspected for the past couple of years that the trend is firmly down.

The reason is simple enough. People buy shares because they want a slice of the profits generated by a buoyant economy and they think they will make more money that way than if they leave their money simply earning interest. Right now they don't believe it, so they don't buy shares.

Sentiment has turned against shares for at least three reasons. First it has become obvious in recent times that globalisation has made business much more competitive and therefore less profitable. Second they realise that the US consumer, and to a lesser extent the rest of us, have overspent these past few years, borrowed too much and now need to slow things down - which is clearly bad for business. Third they fear that they have been conned by unscrupulous businessmen into believing businesses were much more profitable than they appeared to be.

Overall people have been expecting too much too quickly, they have let their expectations run ahead of what is possible and there now has to be a pause while reality catches up.

Any of those factors would be enough to send shares spinning on their own. Here you have all three and that is even before you begin to worry about the situation in the Middle East, the terrorist threat, the risk of disruption of oil supplies, the fumbling ineptness of the leadership in the US Treasury, and the ill-considered trade protectionist agenda embraced by the US President.

The real question in falling markets is not why they happened but how long will it go on, and how low can they fall. No joy here either I am afraid. The health of the US economy is the key and it is fast running out of cash. It has a huge deficit on trade, and it will shortly have a budget shortfall too - which means it is not raising enough taxes to cover its bills which have, of course, been greatly inflated by the costs of its adventures in Afghanistan and elsewhere. Wars on terrorism are not cheap, even for the world's richest nation.

It is also an uncomfortable fact that even after falling by a third from its peak the American market remains as overvalued today as it was at the peak in 1929, and yes I do mean the peak. After that, by 1932, American shares had fallen by 90%.

Happily no one is quite predicting that now, but most academic studies say shares should fall by at least another third and possibly up to 50% to get back to the levels and relationships between profits and interest rates which have been established as the norm over the past 100 years. If this happens all in a rush then it will be hugely disruptive and painful - not least for the City and the investing institutions.

But it is also possible that the adjustment will come over time - with shares moving sideways or up and down within a narrow range for years. That is what happened for example after 1966 and on many other occasions. Shares may be a good long-term investment - but it does very much depend on when you buy and sell them.