News

17/07/2008 - The darkest hour is just before the dawn

An interesting piece of commentary fron John Husselbee, Chief Executive, North

"The papers may be full of doom and gloom today but history has proved that the time to invest is often when markets appear to be at their most bleak. I have been here before and seen markets recover. I firmly believe that although things can get worse before they get better the current environment offers plenty of potential for the canny investor.

There is no mistaking the fact that these are troubled times. A quick glance at the headlines, on both sides of the Atlantic, clearly highlights the problems the world is currently experiencing. Rising food and oil prices, falling house values, the Bear Stearns rescue, Freddie Mac and Fannie Mae, the collapse of Indymac, dipping consumer and business sentiment numbers are all contributing to the gloom. The Western World is waking up to the fact that the party it’s been enjoying on the back of cheap and plentiful credit, has come to an abrupt end. The credit supply has dried up, the lights have come on and our dance partner suddenly doesn’t look too good in the cold light of day, with a hangover.



We are in the grip of a credit crisis that continues to wreak havoc in the aftermath of the collapse of the US sub prime mortgage market. House prices in the US and UK continue to fall and activity in the housing market has almost come to a standstill. Assets are depreciating in value and this makes it difficult for individuals and institutions alike to fully assess the extent of their potential losses. This isn’t helping the recapitalisation of the financials sector, with rights issues or investment from sovereign wealth funds or private equity being met with varying degrees of success.



Whilst the drama of the credit crisis plays out, inflation is rearing its ugly head, fuelled by rising oil and food prices. In the UK, June’s inflation figure hit 3.8%, with core inflation reaching 1.6% and the Consumer Price Index reaching its highest point since its launch in January 1997 - not that anyone is really convinced of the official figures. Inflation is seriously hindering the ability of the Central Banks of the developed world to intervene in any meaningful fashion. The Federal Reserve and the Bank of England have both clearly shown their desire and willingness to help stimulate markets and guide their respective economies safely through the credit crisis. However, they find themselves between a rock and a hard place, with the effectiveness of their tools blunted by the need to avoid creating an inflationary spiral. With the Governor of Bank of England, Mervyn King, expecting inflation in the UK to hit 4% by the end of the year and experts predicting higher levels still, the prospect of anything other than higher interest rates in the coming months looks fanciful. The feel good factor that politicians so want to create, in order to win votes, seems a million miles away today with the cost of living rising and the chances of unemployment increasing too



The immediate outlook may be gloomy but there is light at the end of the tunnel. It is not unusual, following dramatic market falls to see strong, sharp rallies, as witnessed in January and March of this year. The question is when will the market bounce back and how high will it go? We have seen markets after similar falls find themselves on average 10% higher six months later and up 12% a year on. We see no reason why history cannot repeat itself on this occasion. Stockmarkets are currently oversold on almost any valuation metric used by fund managers or global strategists. Put bluntly, these markets are cheap. Can they get cheaper? The last few weeks have proved they can but the bottom is fast approaching.




We are not selling, or should I say, giving away good value at these levels. The reason to be cheerful is that equities are not only cheap historically but also cheap versus other asset classes, bonds in particular. Long term value is there to be found and it is a question of when, rather than if, that value will be realised. The exact timing, however, can never be predicted with any precision. The stockmarket needs a catalyst, such as a fall in the oil price; bailing out of Fannie Mae and Freddie Mac; earnings surprises or more M&A activity. This will create the bounce the market is looking for and which will be exaggerated as it flushes out the short sellers. After the bounce, the question is how sustainable the resulting rise will be. Interestingly, sentiment indicators have got back close to the levels seen in January/ March of this year. The VIX, a measure of option volatility, has risen to the mid twenties but not the thirty plus zone seen previously. This suggests that we are near the bottom but not at the bottom. We are looking for the market to bounce and view the VIX as the lead indicator. Those with cash in their portfolios should plan to use it wisely. The herd for now is currently rushing, as one, for the small exit. The value and the contrarian's view is to buy equities."

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