By MARCEL PORCHERON 17/08/2007
Investors around the globe have endured a torrid week, with stock markets plummeting in the wake of yet more concerns over a so-called ‘credit crunch’. Is there reason to panic and should you be running for the hills?
| "previous rate rises appear to have finally caught up with less credit worthy US homeowners..." |
The main driver behind the recent falls appears to be the big increase in defaults of US sub-prime mortgages. Although the US hasn’t raised interest rates for over a year, previous rises appear to have finally caught up with less credit worthy US homeowners who took out mortgages at relatively high interest rates in the past. This has led to a flurry of repossessions and US sub-prime lenders facing a crisis as the bad debts pile up.
While the sub-prime sector is tiny in the greater scheme of things and has little to do with the British economy or the health of British companies, British stock markets have nonetheless plunged. The problem is that negative sentiment surrounding the US has filtered across the rest of the world and there are fears the credit crisis could spread. The reason that almost all assets have soared in value over the last four years is that interest rates have been low, making it very cheap to borrow. This has fuelled a spending bonanza by both institutions and the public and with so much money chasing a finite supply of assets, prices have unsurprisingly risen. However, an unwelcome by-product has been higher inflation, prompting Central Banks around the world to increase interest rates in a bid to slow things down. The worry now is that these interest rate rises may prove to be too effective, causing a spate of repossessions and bad debts along with a big slowdown in spending. At its simplest level, if consumers are struggling to meet rising mortgage payments they’re less likely to spend so freely in the high street and on other goods and services.
The general unease has not just been reflected by falling stock markets, investment grade corporate bond issuance in the US has also fallen to its lowest level for three years with a number of companies either cancelling or postponing debt issues.
| "However, it’s not all doom and gloom, corporate profits are still mostly healthy..." |
However, it’s not all doom and gloom. Corporate profits are still mostly healthy and the majority of consumers have yet to feel the ‘credit crunch’ bite so, aside from stock market volatility, it’s life as usual. If you believe that the companies in which you are invest are fundamentally sound, as fund managers invariably do, then it’s hard to feel particularly negative about prospects moving forwards. Some commentators have also suggested that the correction is healthy, as the market is re-pricing risk across different assets that had become distorted following four very strong years of rising prices.
Markets also picked up today as the US Federal Reserve hinted that it might cut its headline interest rate next month. It has also slashed the rate at which it lends money to banks, by 0.5%, to help them support markets.
The $64,000 question which no-one can answer accurately is whether the recent turmoil is simply a short term correction in the financial markets or the start of a longer term problem that will spread into the real economy. Opinion is divided and it’s easy to state a case for both.
Our view is that the chances of a full-blown recession are slim. The recent volatility may well carry on over the rest of the year and there could be some more pain to come, but provided you are investing for 5-10 years and hold a good spread of investments in your portfolio you should be well placed to weather the storm. If you have concerns or wish to discuss your portfolio then please call our advisers on 020 7189 9999.