Don't Lose Out On Investments

Posted on: 08 April 2008 by Gareth Hargreaves

Volatile markets should not scare investors into selling shares or not investing new money, says Graham Kerner.

This week mortgage lenders continued to withdraw deals and increase rates as they sought to reduce lending risk and improve their margins, our expert explains.

The Bank of England's Monetary Policy Committee meets this week, and expectations are for a quarter point cut although higher inflationary pressures are causing a dilemma for the Bank.

Cautious Optimism

Global financial markets finished on a strong note last week, despite what might have been perceived as very bad news from the banking sector, thus well and truly confounding the pessimists.

On Tuesday, Swiss banking giant UBS calmly announced that it was writing down a massive $19 billion on its US real estate and structured credit products as a result of the credit crunch. The latest news brings its total write downs to $37 billion but, as The Independent noted, in an attempt to draw a line under its disastrous excursion into structured credit the bank also announced a SFr15 billion (£7.5 billion) rights issue. The scale of the loss meant it was inevitable that heads would roll and the bank's chairman, Marcel Ospel, duly resigned after weeks of mounting pressure, as it became clear that the blue-chip bank was suffering 'reputational' damage.

In reaction to the news, the company's share price promptly rallied 12% as investors saw the moves as evidence that banks were finally facing up to their challenges and as The Financial Times commented, the markets welcomed the write downs as a benchmark for sizing up problems across the rest of the sector.

So a mood of cautious optimism crept back into financial markets as equities rallied, credit spreads tightened - meaning slightly cheaper money - and the US dollar halted its recent slide.

However investors' nerves were kept taut following a downbeat assessment from US Federal Reserve chairman, Ben Bernanke, and another poor employment report. The Times reported that US employers cut more than 80,000 jobs last month, triggering the sharpest fall in the number of Americans in work for five years. The worse than expected figures fuelled predictions on Wall Street that the Fed will now cut interest rates by a further half-point at the end of this month as the evidence mounts that the economy is already in recession.

Summing up sentiment, analysts at ING Markets said, "Substantial rate cuts remain very likely in this environment." So unsurprisingly, the money markets moved to price in cuts, with interest rate futures rating the chance of a 50 basis point (half percent) cut at 38%.

In the commodity markets it was quiet, although oil edged ahead marginally as petrol prices hit a record high on supply concerns prior to the US driving season. Gold and silver continued their correction, with the precious metals' prices settling some 10% or so below their highs seen a few weeks ago.

With the markets embracing the constructive efforts of UBS, news that Hank Paulson, the US Treasury Secretary, is planning the most far-reaching overhaul of the regulatory system since the Great Depression was only partially well-received, as banking and consumer groups threw in a litany of caveats that potentially could see reform bogged down in argument.

However, by the end of the week, investors had good reasons to feel more positive about the outlook, with this new-found confidence being reflected in global equity indices. Along with Tokyo, Wall Street ended up over 3% higher and in London the FTSE100 advanced almost 4%, with other major bourses mirroring similarly large gains.

Golden Age Closes

Here at home it was impossible not to have noticed the fact that getting a mortgage these days is proving more problematical.

As The Times highlighted, one by one the country's largest lenders have tightened the screws on borrowers by raising mortgage rates or withdrawing deals. Last week, Lloyds TSB, NatWest and then HSBC joined the ranks, illustrating the fact that lenders are becoming more choosy - rejecting riskier borrowers and turning away those with blemished credit records.

As The Financial Times commented, for consumers the golden age of low-cost mortgages financed by a combination of cheap money, low interest rates and intense competition is well and truly over. So it was really no surprise when the paper reported that around a third of housing deals are falling through as buyers discover that bank finance has dried up. Apparently, a shortage of mortgage deals is also being exacerbated by downward valuations by the banks - anything between 5%-10% is common it seems -causing the sharp increase in the fall-through rate, according to estate agents such as Savills and Connells.

To give a feel for the sea change in the market there are now 4,720 different mortgage deals in the market compared with 15,599 last July, before the credit crunch started.

It's unlikely to get any easier according to the Bank of England (BoE). In its latest Credit Conditions Survey, the Bank found that lenders expected the squeeze to intensify in the next three months and, although demand for mortgages has been flat, it is expected to decline in the months ahead.

On the point of UK price falls, anecdotal evidence suggests that new-build flats may have been hard hit, but that Acacia Avenue is weathering the downturn relatively well.

However as The Financial Times also noted, in the US the housing slump has migrated beyond the trailer parks and rust-belt cities, having finally arrived at the Hamptons - summer playground of the Manhattan elite. The Long Island resort towns have seen prices fall by 19% in the last quarter, with holiday homes hit hardest. Mind you the falls need to be seen in context: prices quadrupled between 1998 and 2007.


Tighter credit conditions and signs that the UK economy is slowing is creating a cacophony of calls for interest rate cuts when the Bank of England's Monetary Policy Committee (MPC) meets this week.

However the real problem for the MPC is inflation - the Bank is charged with keeping it - as measured by the CPI - below 2% - which is rising too quickly. There was more evidence last week, with inflation in the UK's manufacturing sector rising to a 13-year high as a result of higher input (raw material) costs. Again last week, the Bank's governor Mervyn King warned that inflation will sharply exceed target, stressing that the MPC faced a "delicate balancing act" on deciding whether to cut rates from 5.25%.

However in the City the majority of economists expect a quarter point cut following data showing the economy is growing at its slowest rate for five years and, according to The Sunday Times, the CBI is also pressing for not one, but two cuts over the coming months as business confidence takes a battering.

The Waiting Game

Investors are often cautioned to do nothing when markets are difficult or volatile, but the behavioural psychology of investing again often leads us to feel we should be doing something: the trouble is we can end up ruing the decision.

The voice of experience in the form of Warren Buffet observes, "You do better to make a few large bets and sit back and wait . . . there are huge mathematical advantages to doing nothing."

There is plenty of statistical evidence to support Buffet's maxim because history tells us that trying to second-guess and time the markets is expensive.

During the dotcom crash of September 2000 to March 2003 the UK All-Share lost 51.5% of its value, but in the five years to March this year it gained 86.2%. But if you missed the first 12 months of the rally your gain would be just 32.7%. Similarly, in the 1987 Crash, the index fell 36.6%, but rallied 53.9% over the next five years and had you again missed the first 12 months your gain would have been halved to 26.6%.

There are even more spectacular figures, but the point is a simple one: private investors should sit tight during falling markets and better still, think about investing new money at lower prices - then as Warren Buffet would say, do nothing.

Of course there is nothing like the ‘bottom-line' to crystallise the mind and potentially galvanise one into action.

As The Sunday Telegraph pointed out to its readers, many investors will shortly be receiving their Individual Savings Account statements and these are unlikely to make good reading following the sharp falls in world markets during the first quarter of this year. The paper sensibly shared a few suggestions along similar lines, by advising people not to panic, make sure your portfolio is diversified and lastly to take advantage of lower prices.

Being with a good fund manager helps of course, and topping the UK Equity Income sector is Neil Woodford of Invesco Perpetual, who has an AAA Citywire rating and manages funds for St. James's Place.

Investing in high-income equities has often proved to be a good, more defensive strategy to ride out the type of short-term volatility we are seeing. The reason for this, according to fund manager Nick Purves of Schroders, who also manages funds for St. James's Place, is simple.

"Over a hundred years of data has shown that investing in lowly valued, higher yielding stocks ultimately produces better returns than investing in low yielding, highly valued shares. Obviously you have to be careful in stock selection, but buying a quality stock that is lowly rated can often lead to strong share price growth as well as good dividend income.

"I currently have around 30 stocks in my portfolio, which are solid, blue-chip companies with a strong track record of paying rising dividends. But it is only recently that the market is beginning to seek out these lower risk areas, although I am confident that over the coming months my strategy will be fruitful as institutional investors de-risk their portfolios.

"Companies such as Vodafone, Unilever and Pearson have huge potential for growth, yet are trading on low values and there are others like them which I own. Of course, one does need to be patient, but I am sure that in three years time investors will have been well-rewarded in terms of not just income, but also capital appreciation too."

7th April 2008

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