What happens next for London shares?

Since 2003 the London stock market has been travelling gently upwards. Indeed not long ago it hit its highest levels for some four and half years, but after a panicky May for investors and stockbrokers alike, everyone is preparing themselves for a potentially unsettled summer.

Volatility in shares can be an unnerving experience at the best of times but in the past couple of weeks, the UK stock market has seen nearly all of its gains for 2006 eroded due to concerns about the strength of the US dollar and inflationary fears.

The FTSE 100 share index has lost over 400 points with some £90 billion being wiped off the overall value of the index. After three years of steady continuous growth, the question that is on everyones mind is whether the bull market has come to an end or is this just an overdue correction?

There have been periods of volatility in share prices before. In October last year, for example, the FTSE 100 dropped 300 points or 5% after inflation touched 2.5% in September. However, the market soon recovered.

A lot of analysts have made comments in the media recently saying they felt that the stockmarket was overdue a correction due to the low cost of borrowing and the recent frenzy of merger and acquisition activity. Others in the market have taken a much more pessimistic view such as Anthony Bolton, who manages Fidelity's Special Situations fund. He addressed an audience at the Securities & Investment Institute recently and surprised many by saying, "The current bull run has gone on for three years, which is a long time. When you look at the charts of some stocks, you get the feeling that this party has to end. Is this a correction or the end of the bull run? I think it's more likely to be the end of the bull run."

The sell-off has not been confined to the UK either. Stockmarkets around the world have plummeted with investors running for cover. The Indian stock exchange suffered such heavy falls in one day that the decision was made to suspend trading until calm was restored.

Wall Street 'sneezed'

It was pressures in the US markets that initiated the global downturn. With the dollar weakening to its lowest levels in over a year against the pound and the euro, coupled with a rise in inflation, investors and stockbrokers became concerned that the world's largest economy may yet again have to raise interest rates and potentially stifle future growth.

It really does appear to be the age old adage of "when Wall Street sneezes, everyone else catches a cold". The downturn has affected private investors badly. Many of those scared away from the stock market during the last bear market had only just begun to return. In particular, the take up rate of ISAs has been particularly high this year and already the value of these accounts has significantly diminished.

Many stockbrokers though are holding their nerve, firmly of the belief that this is just a market correction and are actually viewing the current climate as a good buying opportunity as the price of shares become cheaper. Hilary Cook, director of investment at Barclays Stockbrokers said, "This is a clear buying opportunity and looking back on this in ten years time, it will not even register as a blip and investors should have more of an iron stomach."

One investment tool that has certainly not helped in recent weeks has been the Contract For Difference, or CFD. This type of investment only requires the investor to put up a fraction of the overall cost of the investment, instead of having to pay the full amount immediately. The investor decides whether his investment is likely to rise (go long) or to fall (go short). Those investors who chose the "rise" option will have had to make immediate payments, known as margin calls, for every point that the market dropped. Depending on the size of their overall investment, this could equate to a large amount of money, forcing them to sell off other shares that they may hold in order to meet the margin call. Therefore CFDs can actually exacerbate a falling market creating a vicious circle.

With the stock market fluctuating wildly on a daily basis, investors need to remain calm. Attempting to time a stock market exit is as difficult as trying to time entry. Recent investors would do well to remember that shares are not a short term investment.

02 June 2006 © Moneyextra.com

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