What next for shares and investors?

The origins of the turmoil in financial markets can be traced back to the low interest-rate policy of the US central bank, the Federal Reserve (Fed), which reduced its key federal funds interest rate to just 1% in June 2003. This caused a boom in sub prime mortgage lending. Estimates place the size of the US sub prime mortgage market at around US$600 billion in 2006, up from roughly US$120 billion in 2001.

Problems in the US subprime mortgage market first became a broader financial-markets issue in February, when HSBC was one of the first big banks to admit to heavy losses in undewwriting poor quality US loans.

The question now is whether the worst of the chaos is behind us or whether there is more to come? Angus Rigby, Chief Executive Officer, TD Waterhouse, commented, "Fears of a global credit crunch were allayed slightly this week after European central bankers and four big US banks rallied together to pump additional funds into the markets."

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The Fed, the Bank of Japan and the European Central Bank have injected billions of dollars into money markets. The Fed also cut the discount rate, the interest rate is charges to bank on loans from their regional Federal Reserve lending facility on August 17th and the money markets are expecting between two and three US interest-rate cuts by December.

However, Jason Hollands of F&C Investments notes, "Professional investors are split between those who believe that shares look exceptional value and that current markets could represent a 'summer sale' and those, like our own Ted Scott, who caution that the pain could be set to continue for some months."

Stockmarket historian David Schwartz believes the FTSE 100, down 10% since its peak mid-June could have as much as another 10% still to fall before it recovers. "When corrections like this occur, they go down at least 20%," said Schwartz.

Countrywide, the biggest US mortgage lender is now warning of a housing-led recession in the USA. On a more positive note, French bank BNP has announced it will be reopening for business the three funds it stopped trading in, saying conditions have improved enough for their values to be calculated again.

What should private investors be doing?

So far, it would seem private investors have been holding their nerve. As banking stocks have fallen over the last two weeks, TD Waterhouse reports that its clients have taken the opportunity to increase their exposure, buying into Barclays, Royal Bank of Scotland, Northern Rock and Lloyds in the hope that current market conditions are a temporary blip that will soon be forgotten.

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Elsewhere, there are press reports suggesting that legendary US investor Warren Buffet is ready to 'pounce' back into the battered stockmarket with a multi-billion cash war chest.

Comments F&C's Hollands, "The answer as to whether you should invest in the markets now really depends on the timescale you are willing to stay in. Providing you are willing to commit to the markets for a long-duration of typically five years or more, we believe the returns on shares will be, as they have been historically, attractive over such a time scale."

Hollands stated that the shorter term picture for private investors trying to 'call the bottom of the market' is extremely difficult to predict because the full extent of problems in the financial system are not yet known and will take some time to unwind.

A leader article in The Economist (18/08/07) suggested, "Because this crisis taps so deeply into the newly devised structures of finance, anyone who says the worst is definitely over is either a fool or someone with a position to protect. As risk has become bewilderingly dispersed, so too has information. Nobody yet knows who will bear what losses from mortgages - because nobody can be sure what those loans are really worth."

24 August 2007 © Moneyextra.com

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