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24/01/2008 - Market Commentary from Ken Forman

What's Up?

The equity market meltdown in the past few days has taken us beyond the volatility phase into bear market territory. Although all equity markets tend to move in the same direction, particularly during a sharp correction phase, the UK equity market has been one of the worst performers in the past year ('beaten' amongst the major markets only by Japan). The FTSE UK All-share Index is getting on for 20% off its summer high and its dividend yield is up to 3.5%, as high as it has been since the close to the bottom of the last bear market in 2003. Meanwhile, risk free assets (gilts) have been strong while some commodity prices continue to soar.

Traders had many reasons to drive share prices down. What was initially seen as a one-quarter effect on bank profits (in Q3 last year) has spread out into concern that profits across a broad spectrum of the market are at risk for at least the next year as the global economy turns weaker. The US is at the centre of the concern and neither lower interest rates nor the prospects of a fiscal stimulus (easy to get through in an election year) have done much to ease the worries that a recession looms.

Fear has taken over from rational analysis. On most of the measures I look at, valuations of equities are cheap (some are very cheap) and gilts are dear. That does not mean they will go up from here but it does provide some comfort for those with existing holdings and provides encouragement for those tempted to buy. Measures of investor sentiment (a contrary indicator based on the idea that fear is worst at the bottom of the market) are also supportive although not yet at extreme levels. For those who can afford to take a long-term view, buying equities at current levels should ultimately prove to have been a good decision. However, there is an old Japanese saying "never try to catch a falling knife" which is sometimes well to remember when trying to gauge the bottom of a bear market when shorter-term performance is at stake.

In December, I reduced tactical risk exposures in the Liberation Funds believing that the way in which the economic and market environment could evolve was becoming murkier than normal and it was right to step back until the view became clearer. The recent fall in equity markets has probably more than discounted the deterioration in the economic environment and we are closer to the point at which I would be prepared to increase the tactical exposure to equity markets again but I would prefer to wait until the 'knife' looks as though it has landed. There is still much that can go wrong, not least of all because we talk ourselves into it.

Ken Forman
Jan 22, 2007

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