Investment Commentary: The Perfect Storm?

Brian Tora is one of the City's most respected financial commentators. Previously he held the post of Investment Communications Director at Gerrard Investment Management Limited. He writes a regular monthly column on investment issues for Moneyextra.

Amongst the old adages that we in the City rely on to give us a steer for the future is one that suggests the performance of the stock market in January sets the tone for the rest of the year. I hope on this occasion this piece of wisdom proves wrong. January was dire for investors - one of the worst performances on record. If this is what the year has in store, then heaven help us.

Seldom has the investment outlook appeared so difficult to judge. On the one hand some form of recession in the USA looks unavoidable. On the other, interest rates are coming down rapidly on both sides of the Atlantic, while the growing powerhouse that is the Far East looks increasingly capable of picking up the slack from America. True, all the victims from the credit crunch have yet to make their appearance, but the overall picture is not all the unalloyed gloom January's stock market performance would have us believe.

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Investors are nervous, though. Volatility is unsettling all but the most experienced traders - and even they have been heard to remark how difficult life has become. And there are things going on they do not fully understand. Just what is a monoline insurer, for example? This latest group of casualties from the sub prime debacle has yet to make the extent of their contribution to financial insecurity clear.

These organisations existed primarily to guarantee loans issued by local authorities in the US to help fund their spending programmes. Unfortunately they extended the concept to back financial instruments comprising sub prime mortgages. The anticipated write downs of these bonds could damage their own credit ratings and thus their ability to guarantee other bonds to which they attach their name. In short, this sector could implode.

But knowing how crucial their stability is to the whole American financial system is leading to bail-outs from the banking giants. Of course, these massive institutions are not without their own problems, not the least of them being the need to re-build their balance sheets from the ravages wrought by sub prime and the collateral damage that has resulted. And where is the money for this exercise to come from? If early indications are anything to go by, from those nations that have benefited from the boom in commodity prices and the migration of business East.

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So if one consequence of recent market turmoil is to be made apparent, it is the way in which the transfer of economic power east is being accelerated by events in the indebted West. Let us put the situation into context. The World Bank has just cut its forecast for Chinese economic growth this year - from 11.5% to 9.6%. And this is the year when growth of up to 1% would be considered a result for the USA.

At the end of last year two colleagues of mine went on a fact finding mission around India, China and other points East. They came back with a dramatically changed perspective on the outlook for investment. Their focus now is on those businesses able to serve the fast growing consumer society that is developing out there. Moreover, this is a consumer society that has maintained the ability to save.

All in all I cannot find it in me to be too pessimistic with such a background, although I fear we have not seen the last of the bad news on Western economies and the financial sector. So expect volatility to remain and unwelcome corporate surprises to be punished severely. Last month saw a positive balance in the deals done by US corporate insiders. In other words, company directors have turned buyers of their companies' shares. Perhaps they can see light at the end of the tunnel too.

Read last month's: Investment Commentary: New Year, New Opportunities?

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05 February 2008 © Moneyextra.com

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