Stockmarkets 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.
This article was originally featured in the August 2011 edition of our sister publication Money Observer
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.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.