By GRAHAM FROST 01/02/2008
What a month January has been. Equity markets have been ultra volatile as investors became gloomy on the outlook for the US economy and its global repercussions. The FT all share has been moving between 2% and 5%, up and down, on a daily basis as has the MSCI Emerging markets index. From a soft landing investors began to price in a major recession, as banks began to write off huge amounts of sub prime debt. Investors drove down government bond yields as deflation worries rather than inflation worries took hold. The view became that banks balance sheets would become so impaired that lending would cease.
Then the Federal Reserve, piloted by Helicopter Ben Bernanke, flew to the rescue with an emergency rate cut of 75pts. (He apparently once said if all else fails he could drop dollar bills from a helicopter to get people spending). A week later he provided another 50pts cut. That got the market’s attention. And banks have been busy recapitalising themselves, courtesy of sovereign wealth funds from the Middle East and Asia. Those are the same guys that everyone was worried about a few months ago for taking stakes in strategic industries! So everything is now much better and even listed property companies and banks, the ultimate geared investments, were ok to buy again. Is that it?
Banks have owned up to $100bn of the estimated $200bn-$500bn sub prime issues. Assuming the lower figure is more reasonable, that leaves $100bn to go. But that excludes prime mortgages, credit card debt, motor finance, and corporate loans, which could still become troublesome. No problem, plenty of cash left in sovereign wealth funds and rights issues and dividend cuts are always an option.
Then there are other central banks, which can cut their rates too, although the Bank of England, the European Central Bank, and the Bank of Japan do not seem in a hurry to do so. They are still worried about inflation and moral hazard-after all it was loose US monetary policy that got us into this mess in the first place and who wants to bail out reckless lenders and borrowers? What happened to the engine of capitalism, ‘creative destruction’? Nobody likes pain but it seems reasonable to suppose that at some point, borrowers will be so over indebted that their appetite for borrowing will wane and banks will become more circumspect in their lending. The US printing dollars may well come back to bite them in the form of inflation.
So our central view remains that a period of sub trend growth is the most likely outcome and equity markets are offering value now. However, be prepared for further turbulence as economic and corporate data comes out over the year ahead. Remember, equity investment has proven very rewarding over the longer term and we always recommend sticking to the asset allocation that matches your risk profile and long term financial plans. It’s time spent in the market, rather than timing, that’s important.