By ROBERT HARLEY 16/03/2007
The last three weeks have seen global stockmarkets typically fall back by around 5-10%, causing some ISA investors to question whether they should still use their allowance. The six million dollar question is whether this is the start of a sustained downturn or are we simply experiencing a short-term ‘blip’?
To answer this we really need to try and ascertain the drivers behind the recent volatility, then take a view on how serious they are.
| "The most widely held reason is concerns over rising bad debts in the US subprime mortgage market." |
The most widely held reason is concerns over rising bad debts in the US subprime mortgage market. US lenders have been reporting an increase in late payments and defaults at this riskier end of the mortgage market. This was epitomised by GMAC (which is 49% owned by General Motors) announcing that subprime mortgage problems had contributed towards a $651m Q4 loss at its home lending arm. The wider fear is that such problems will slow consumer spending, hitting global growth.
Some borrowers in the UK appear to be struggling too. Home repossessions in the last quarter of 2006 were 22% higher than the previous year, although remain fairly low in actual terms at 22,827. Looking at the bigger picture, total UK personal debt was £1.3 trillion at the end of January 2007, a 10.4% year on year increase, and personal insolvencies increased by 60% during 2006. Any further Bank of England Base Rate rises will likely lead to more bad debts, so inflation figures will prove key.
While some fear rising bad debts could be a bubble waiting to burst, others believe they are more likely to remain a fairly isolated, rather than mainstream problem. It’s a difficult call, but if the latter remains true then aside from causing short term volatility, there should be no significant medium term impact on markets.
There has also been much speculation, although ambiguous, that investors are unwinding ‘carry-trade’ positions. In simple terms, some big investors appear to have been borrowing money very cheaply in Japan (the bank base rate had been 0% for five years until last summer), to fund investments. On this basis even modest investment returns can yield handsome profits. However, the base rate has since risen to 0.5% and, more importantly, the Japanese Yen has appreciated versus the US Dollar recently. The combined impact has been to significantly increase the cost of borrowing, causing some investors to unwind investment positions and then repay loans.
While there appear to be no accurate data on the extent of these positions, it would be fair to argue that if Japanese interest rates continue to rise and/or the Yen continues to appreciate against the Dollar then further carry-trades will likely be unwound, increasing selling pressure in the affected markets.
| "...companies generally remain in good health; profits are high and cash flows strong." |
Against this backdrop companies generally remain in good health; profits are high and cash flows strong. In addition, private equity groups have plenty of cash to deploy in the market. These factors should support corporate valuations, especially after the recent falls! Therefore, it looks unlikely that we are on the cusp of a crash or sustained downturn a la 2000-2003. In fact, many fund managers remain reasonably bullish, believing that the prospects for a number of companies held in their portfolios remain rosy.
The recent downturn has also breathed a little life into otherwise rather tired gilt and investment grade bond markets, bringing a little cheer to investors after a poor 2006. If you haven’t done so recently then now would be an opportune time to ensure your portfolio is well diversified across the main asset types.
If you wish to secure your 2006/07 stocks & shares ISA allowance but are turned off by market volatility, we have two potential solutions. We can arrange for your investment to either be temporarily held in cash or drip-fed into the market in equal instalments over the next six months. Both routes offer some potential protection from further short term falls. Call us on 020 7189 9999 for further details.