Dead cat bouncing? How will the stock market slump affect you?

The faces of the traders were the same pale beige as their uniform Chinos (worn with light blue shirt and loafers). It was a Friday after all and the City's usual pinstripes had been laid aside for dress-down day. But it was a Friday like no other and one of those rare days that will scar the mind of many a City player for the rest of his or her career.

The FTSE 100 index fell 3.7%, ending Friday, 10 August 2007, down 232.9 points with the London stock market seriously rattled. How serious is the situation and what does it mean for those who don't earn a living staring at share trading screens? Almost none of the city commentators are panicking, well not as such.

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Julian Jessop of Capital Economics, in relatively relaxed fashion, said, "It's Friday and it's August: beware of big calls on the back of market moves." He reckons the market turmoil is not serious enough to justify a fundamental rethink of the economic outlook.

Rather less sanguine, Paul Niven, Head of Asset Allocation at F&C, said, "... there is great uncertainty as to how far risks are spread within the financial system and exactly where the losses reside. The market is trading on fear and financials are bearing the brunt of losses."

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However, Mr Niven went on to say, "... the fact that market sentiment right now is so dire presents an interesting opportunity. We are mindful of the risks of a broader based systemic crisis but view the most likely outturn as somewhat less dramatic. There will be ongoing financial problems and many hedge funds are in the process of going to the wall. From a fundamental perspective, however, the outlook for equity markets is still reasonable and, for the patient investor, is good."

Interest Rates

The volatility of the stock market - wonderful word 'volatility', it always seems to get used to describe circumstances where the market is in a nosedive - may, but only may, make a further interest rate rise less likely. Many commentators still believe the Bank of England's monetary policy committee will increase the base interest rate by 0.25% in September.

One of the few voices suggesting that the base rate has already peaked is that of Goldman Sachs' economics team. Erik Nielsen of Goldman Sachs commented, "... the very high risk to our UK MPC call has come down some."

After all, wiping £56 billion off the value of the stock market in one day (£75 billion in two days) is going to go some way to reducing the potential liquidity in the financial system - though having said that, the central banks have actually been pumping money in over the last few days. Nevertheless, the stock market slump and any further falls will certainly chip away at the case for a further rise in interest rates although it seems unlikely that they'll persuade the Bank of England to cut the base rate any time soon.

Shareholders

Falling stock markets are obviously not good news if your shares are among those affected. You're obviously poorer than you were before the falls.

Should you sell now? The answer is almost certainly not. Individuals should consider stock market investing on a medium to long term basis - the market professionals will tell you that now would be the time to consider buying, not selling. Always remember, you are supposed to buy low and sell high - not the other way round.

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What, however, of those who've chanced their arm in higher risk investments - hedge funds, contracts for difference (CFDs) and spread betting. There'll be casualties here and a number of shirts will certainly have been lost. Equally, those who had bet on the market falling by 'going short' may well be ordering their next delivery of champagne.

13 August 2007 © Moneyextra.com

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