Keep a cool head despite the crisis

Oct 8 2008 by Andrew Miller, The Journal

SEPTEMBER was a terrible month for the financial markets and October has so far proved no better. There will be more bad news as the credit crunch claims more victims and pushes global demand down at least another notch.

With events moving so fast, there is a growing temptation to shy away from analysis, and fall back on opinion and instinct. But the complexity of the current situation makes analysis ever more important.

We need to understand what is driving markets and to make reasonable gauges of likely economic developments and the investment opportunities they present.

The financial landscape has undergone the sort of radical transformation which comes about only once in a generation. We are not going back to the world of pre-credit crunch in any way or form and we need to re-think the way the world might look in a decade’s time – both in terms of who will be relatively better off and who stands to suffer.

Policy makers might set different ground rules for agents to operate under and use different forms of targeting and other engagement.

Despite the market’s initial dismissive attitude, the US TARP legislation will eventually help, not least by rebuilding the markets’ faith in policy makers. But legislation and European government intervention, is no ‘magic bullet’. The process will take time and will coincide with an already difficult macro-economic environment. We doubt equity prices can recover much of the lost ground anytime soon, even if there are substantial interest rate cuts. Only in 2009 is it likely that riskier asset classes start to perform again.

Over the one-year term, we still expect the US to make some sort of a recovery, although a formal recession during the last quarter of this year and the first quarter of next looks a real possibility.

Slower GDP growth implies lower medium-term equity markets, although we do remain keen on emerging markets. We expect the dollar to find a floor and then to turn higher, sterling to keep falling over the year and the euro to top out.

Based on long-term equilibrium rates of return calculations, we judge that rates of returns on developed economy equities over the next market cycle will be somewhat lower than in the past and that the return on their bond markets may be slightly higher.

Long-term analysis might appear out of place in the current turmoil, but remains important.

Andrew Miller is regional office head of Barclays Wealth