Markets have further to fall

When stockmarkets lose 10% of their value in less than a week most private investors will be asking two questions: is this a buying opportunity or should I take my losses now?

The answer is, annoyingly, that it depends on your investment goals and your time horizons.

Fund management groups will of course tell you not to panic. This is totally natural as their interests are not best served by an unruly withdrawal of funds under their management.

But the bare facts are that if you cannot stomach a 10% fall in shares you shouldn't be investing in them at all. Personally, my own tolerance for stockmarket falls in my personal pension are up to 40% before I start getting the sweats.

Why? Because I'm not planning to access my retirement funds for another 10 years - ample time for holdings to recover lost ground, one hopes.

That said I think there are very good reasons to believe that the stockmarket glass is half-empty rather than half-full.

Sure, corporate profits have been resilient, if not buoyant. Many companies are awash with dosh and that is feeding through into higher dividends. Smaller companies, trashed in the dash for cash this week, had been outperforming the big battalions the world over for three years.

Unfortunately, however, much of this stockmarket resilience stems directly from the easy money policies that have been adopted since the financial crisis and ensuing the credit crunch broke in October 2008.

Can QE3 steady the ship?

Indeed, the timing of last week's stockmarket rout bares an uncanny resemblance to the flight from risk that occurred after the first bout of quantitative easing (QE) came to an end in 2009. When QE2 looked likely to be launched later that year, risk was back on the table.

This time around the US Federal Reserve, which concluded its second asset purchase scheme at the end of June, has not yet indicated that it is prepared to launch QE3 to help investors ride out global storms.

It may well turn on the money taps again, but now we have a bigger problem than the potential of slower global growth in the shape of the eurozone debt crisis.

As policymakers fiddle (or rather sun themselves during their sacrosanct August holidays) while the eurozone's financial sector burns, markets have become aware of the risk that a little local blaze is in danger of becoming a conflagration.

You only need to see that when investors are prepared to pay banks such as Bank of New York Mellon to hold their cash, rather than receive interest, that it is a sign of just how bad things could still get.

Or that last week's auction of short-term US Treasury bills was so popular that investors were prepared to accept not one cent of interest for lending three-month money to a government that nearly defaulted on its debts at the start of this month.

This is, of course, all good for gold and other tangible, or real, assets.

What can be done?

Frankly, the eurozone is running out of options: they were never easy in the first place, but one clear aim of the bail-outs to date has been to transfer private sector exposure to the public sector. Put another way, it's about transferring the risk that European banks will fail from shareholders onto Europe's taxpayers.

The truth is that Europe's Augean stables have been filled with dung for some years now and they need to be mucked out.

Right now, investors at large are getting splattered by some of the dung being flung. Prepare to be hit by a lot more as the policymakers run out of ways to persuade us that it's business as usual.

Banks don't believe this: there are already signs that they are less willing to lend to each other, because they want to horde what cash they have. That's a sign that stage two of the financial crisis is upon us. And if that is the case, we can expect some pretty nasty months ahead.

Fund managers' thoughts

Bruce Stout, manager of Murray International Trust...

"Events and newsflow of the past few weeks have hopefully at last brought home how critical the situation is in the UK, across Europe and in the US.

"There is no quick fix to the years of debt fuelled spending by both government and the consumer and as such investors should brace themselves for years of sub-optimal growth caused by the stringent austerity measures required. Fortunately there are parts of the world, particularly Asia and Latin America, which are in much better financial health."

Andrew Bell, chief executive of Witan...

"In times like this one has to avoid both being heedless (of the risks) and headless (like a chicken). The speed of equity falls smacks of a market riot point or panic as traders or investors try to price in what they perceive as a rapid change in fundamentals. I am sceptical whether they have changed much. We have an anaemic recovery, not rigor mortis.

"What we have is a crisis of confidence, with the point of greatest risk being a credit crunch in Europe. This is avoidable even if it takes the eurozone a few tries to get it right."

Mark Burgess, chief investment officer at Threadneedle...

"They say a week is a long time in politics, three days is a long time in investments. As we feared, investors globally have become very concerned about weak developed world growth and the consequent debt overhang.

"As is often the case, this is happening in the middle of the holiday season when markets are thin and many policy makers and market participants are away. There is no doubt the concerns are real and rising; US growth is materially below even our pessimistic expectations, whilst moves in European bond markets are increasingly likely to precipitate recession.

"Our view is that at some stage the authorities are going to have to get ahead of the curve, most likely through a globally co-ordinated bout of quantitative easing. Getting to this decision however is going to be complicated and we may well need a catalyst in the form of a significant market crisis to make this happen. Indeed we may be seeing the beginnings of this crisis now."

Anthony Bolton, portfolio manager of the China Special Situations investment trust...

"I believe the recent stockmarket volatility reflects a familiar pattern during this bull market of short, but often very sharp set backs, within a bull trend. For some time I have argued the outlook for the US and particularly Europe is for growth but well below normal growth rates.


"In my view this makes the case for exposure to developing markets and particularly those of Asia even more compelling where growth rates by comparison, even though they are slowing, will still be very attractive.

"History shows that normally extreme equity market volatility as we are now experiencing should be seen as a time of opportunity rather than a time to become more defensive."

John Ventre, portfolio manager at Skandia Investment Group...

"There's an old market adage that goes something like this: 'if you catch a falling knife you end up in a bloody mess'. But when equity markets are as cheap as they are today, then investors have a margin of safety that's a bit like wearing a sturdy pair of gloves.

"European equities are trading at eight times forward earnings and four times forward cash-flow. Cheap by any measure, but bargain basement next to 10-year German bunds at 2.4%.

"European equities have been cheap for a while, so why now? Spanish and Italian bond yields have fallen a little in the last couple of days which is encouraging. Yet equity markets have been weaker for other reasons, namely concerns over weaker economic prospects. This change of focus in encouraging because value arguments trump growth arguments much more easily than they trump fears about the sort of systemic crisis that would result from an Italian default.

"Ultimately, European equity markets are very oversold, as are equity markets generally. I've been keeping plenty of powder dry waiting for an opportunity like this, so for me it's time to put money to work."

Andrew Pitts is the editor of our sister publication, Money Observer, where this article first featured.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

More about