Investment Markets Update - January 2008


Over the last week or so, we have experienced extraordinary circumstances in investment markets with global equity prices suffering wild swings, US interest rates being slashed in response to recessionary fears, concerns mounting over the stability of insurers to the bond markets (the so-called monolines) and Societe Generale revealing a 3.7bn problem caused by a rogue derivatives trader which contributed to the steep falls in European markets as unauthorised trading positions were unwound on Monday.


As all of this comes hard on the heels of the problems impacting the UK Commercial Property sector that we reported in our update to you in December 2007, we wanted to provide you with further analysis of the current situation and our views on the outlook for the future. 

What has happened?

The dramatic falls in global investment markets over the last seven days are largely a result of growing concerns about the likelihood of a US recession and the impact this might have on global ecomonies. Turbulence began as investors, disappointed by President Bush’s much anticipated “re-stimulation” package, retreated from stockmarkets in favour of less risky investments.
Recent economic data has shown that the problems in the US economy have now spread beyond the housing market into everyday activity impacting on consumers and companies alike. The continuing fall-out from the US sub-prime mortgage problems has also resulted in a significant tightening of lending criteria (the ‘credit crunch’) amongst financial institutions round the world which in itself has an impact on economic growth and stability. Understandably, this data has only served to increase already weakened investor sentiment across the globe.


UK Stockmarket

On Monday, 21st January, the UK’s main benchmark index, the FTSE 100, fell 5.5%. This was the largest daily fall since September 2001 (9/11) but was followed by a 3% bounce on Tuesday. The index finished the week down 0.55% but we witnessed wild volatility with daily swings of over 100 points becoming a regular feature.
However, to put this into context, while these falls were significant, they are no more than the similar slump that we experienced in July and August last year – a market correction that much of the media seems to have forgotten - and still a far cry from October 1987 when the FTSE 100 fell 20% in the space of two days.  


Global Stockmarkets

Other major global markets have suffered similar falls and, whilst the US market was closed on Monday 21 January for a public holiday, the US Federal Reserve acted quickly by cutting interest rates by 0.75% to 3.5%. This is the largest cut by the Fed in more that 20 years and was followed by a further 0.5% reduction to 3.0% on 30 January.
This overall reduction in interest rates of 1.25% in 10 days is aggressive by any standards and is the fastest easing of monetary policy since 1990. It appears also that the Fed has left the door open to more cuts with market experts predicting that policy makers may reduce the rate to 2.25% by mid-year.
There is clearly a focus on using these measures to stimulate the economy and ease the tensions in financial markets along with the associated credit disruption. While this aggressive approach has brought some stability, it remains to be seen how successful it will be over the longer term given the extent of investor and corporate recessionary fears.



Recessionary Fears

Economic growth elsewhere in the world looks stable, at least for now, but we do anticipate a situation where economic conditions over the next year will be more challenging than at any time for nearly 15 years. There is little doubt that growth rates both at home and in much of the world are set to slow sharply over the next 12 months as the impact of the credit crunch spreads and the US struggles to avoid recession. Whilst we share what still appears to be a widely held view that a UK or worldwide recession may be avoided, it is important not to overlook the fact that a recession in the US could have major negative consequences on all global economies as US companies and consumers are still big spenders for almost every major economy.


The Banking Sector

Since last summer and the beginning of the Northern Rock saga, banks generally have been under close scrutiny as concerns have grown about the losses they have incurred from the use of complex investment instruments and the impact on their balance sheets.
Consequently, share prices have fallen sharply contributing to the general malaise in stockmarkets across the globe and increasing concerns that, unless the current lending restrictions are relaxed, this may have an impact on economic growth.
To eradicate these fears and help move the banking sector forward positively, it appears that we need to see the banks clearing their balance sheets of bad debt through write offs, re-structuring and possibly reducing dividends. Many of the major banking institutions are announcing results during the first quarter of 2008 and, provided there are no furthers shocks to the system, we hope that stability will be restored and pave the way for a return to some normality. The alternative to this, as we have witnessed during the ongoing Northern Rock saga, can have a catastrophic affect on our markets and contribute to already weakened investor sentiment.



What now?

Whilst these swings in market conditions are uncomfortable to investors and advisers alike, we believe that these events should be considered in the broader context.
Martin Walker, a fund manager with Henley based Invesco Perpetual recently wrote “At times like these, it is important to draw a distinction between the sentiment that drives short-term market direction and the fundamentals that drive long-term market performance. It is sentiment that is undermining markets at the moment but, from a fundamental perspective, valuations are currently at very low levels and this should limit the downside from here and provide long-term market support. The present situation is markedly different to the economic slowdown in 2000, which the stockmarket approached from very high valuation levels. We, ,therefore, remain confident that a balanced and structured investment approach can provide attractive returns going forward, particularly over the longer time periods.”



Market Timing

When the market climate is uncertain as it has been for nearly a year now, investors often become nervous and lose sight of their long term investment goals. It is often tempting to postpone new investments, and even to sell current holdings with the aim of re-investing when stockmarkets stabilise. However, we firmly believe that if investors are able to take a long-term view, it is often best to hold onto investments through periods of volatility like this.   
It goes without saying that we would all like to be able to predict the movements of the market, buying at the bottom when prices are low and selling at the top. This is known as ‘market timing’ and, unfortunately, is very difficult to accurately predict, particularly in periods of extreme volatility. Getting it wrong can significantly affect the performance of investments. Selling at the first sign of a downturn can prove particularly bad as sharp falls in markets are often followed by sharp gains. While it can be tempting for investors fearing further losses to sell their investments, the risk is that they are locking in losses and missing out on potential gains.
The long-term performance of equities demonstrates that, rather than trying to time the markets, it can be enough just to be in them. Research shows that investments made when the market has already begun to recover, and those made when the market is still falling, have still paid dividends. In contrast, waiting for a better time to invest can cost investors dearly. As the table below illustrates, investors who remained fully invested in the UK market over the last five years would have received returns in excess of 60%. Investors who missed out on the ten best days would have seen their returns cut to just 40%, while those who missed the best 40 days would have made just 3.9%.


Returns over five years – effect of missing best days

Market Index Fully Invested Missing best 10 days Missing best 40 days
UK FTSE All Share 63.4% 40.0% 3.9%

Source: Bloomberg/Datastream. Returns from 01/09/02 to 28/08/07.
UK Commercial and Global Property
When we wrote to you in December 2007, the average annual return for the UK commercial property sector was -5.8%. This average up until the 1st January 2008 had fallen to -19.1%. The issues affecting the sector have resulted in some individual funds finding it necessary to restrict withdrawals while properties are sold and liquidity raised, in some cases meaning that investors cannot get their money back for between 6 and 12 months.    
As with equity markets, negative investor sentiment has been the driving force behind large scale sell offs in this sector. However, there are signs that we may be approaching the bottom of the market with property valuations starting to stabilise, funds reporting a return to inflows exceeding outflows and some new ‘opportunity’ funds being successfully launched to pick up attractive properties at significantly discounted prices.
We continue to believe that the UK and global commercial property sectors will produce returns of around 6%-7% from mid 2008 onwards and remain satisfied that investment in these asset classes should continue to form part of a well diversified portfolio.


In for the long haul

We have no doubts that the next few months will see continuing volatility in investment markets but what no-one knows at this stage is how long this will continue and how severe it will be. While this situation persists, sentiment and fear will continue to be major influencers.
Interest rate cuts and other measures introduced by central banks may help stimulate economic growth but we have not lost sight of the significant issues that continue to hamper progress such as the US sub-prime mortgage sector, problems in the banking sector and the levels of personal debt in the UK.
Our approach of assessing economic and market data on a daily basis continues and, having met with some of the leading UK investment fund managers over the last few weeks to better understand their views on where we might be heading, we have decided to maintain our stance that no changes should be made to our existing investment portfolios, asset allocation strategies or fund selections. 
As always, we recognise that individual circumstances are very important and can change rapidly so, if you have any questions or concerns either with regard to this update or your personal financial planning, please do not hesitate to contact us.   

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