By GRAHAM FROST 18/03/2008
The bail out of Bear Stearns in the US over the weekend was meant to reassure financial market participants and prevent runs on other banks. Investors, however, have taken it as a sign that there is more bad news to come as the investment bank reporting season gets underway. Little more than a year ago Bear Stearns share price was $169 but the weekend buyout by JP Morgan was at just $2! How low is low? Are banking stocks bottoming out?
Estimates of the eventual total write offs from sub prime mortgages and other borrowings has steadily risen from $50bn initially, to $800bn today, as the financial news from US continues to deteriorate. Of course, if you extend write offs to the widest range of assets, including high quality paper, that number can be as big as you want. Certainly the immediate outlook for the banking sector remains unclear. Nigel Thomas, manager of Framlington UK Select Opportunities fund and Neil Woodford of Invesco Perpetual Income fund, still believe there is more pain to come and have positioned their portfolios accordingly, both taking a massively underweight stance towards financials. Yet no bank can withstand a run by depositors who have lost confidence in the security of that institution. Northern Rock showed us that in the UK. Paradoxically, what’s bad for one bank’s shareholders is good in the long run for other banks’ shareholders as business migrates. The problem therefore is more a short term confidence crisis, which will only be overcome as the financial system becomes more certain in each others solvency and resume lending and risk taking. That will require more transparency and more write offs as part of a cathartic blood letting. Eventually, confidence is restored, share prices bottom, and start moving up again. Nobody can be sure on the timing of that but as an investor you should prefer buying into weakness because its cheaper to do so rather than strength when it is expensive to do so.
Recent volatility has emphasised the importance of pursuing active asset allocation and of having a balanced portfolio with exposure to a range of different asset classes. Equities though remain a key part of any portfolio and investors should not get too concerned about trying to pick the bottom of the market, as it is far more dangerous to miss the upswings when they come. Fund managers like Philip Gibbs of Jupiter Financial Opportunities who have been adopting an extreme defensive stance will be able to capitalize on cheap prices.
For investors who remain unsettled about the outlook, we recommend that you utilize your ISA allowance as once lost it’s gone forever. Park it in a very cautious product that has cash like characteristics until you feel more confident.