The opportunities are there for investors who savour risk

Mar 19 2008 by Andrew Miller, The Journal

RECENT news from the financial markets has spooked investors. The rescue of the US investment bank, Bear Stearns, has been followed by further market volatility and sharp dips in share prices, most notably in the financials sector.

Current uncertainty, particularly as regards the health of the US economy and the extent of the sub-prime crisis, continues to prove highly destabilising.

In the short term, worries about the possible failure of other financial institutions could depress share prices further. Indeed, some national newspapers have already started to speculate that the global economy could be on the brink of a 1930s-style Great Depression, adding to the sense of gloom pervading markets.

Another challenge is that inflation data has been stubbornly strong, particularly in the UK and Europe, meaning that the Bank of England and the European Central Bank have not been able to follow the lead of the US Federal Reserve (Fed) and cut interest rates aggressively to mitigate the adverse effects of the current crisis.

A further cause of concern is that there is no scope for meaningful tax cuts in the UK if the slowdown does begin to bite hard on this side of the Atlantic.

The good news is that the Fed is clearly willing to move fast, and to make cheap finance available – and in new forms if necessary – to ease the pain of the credit crunch. Recent US interest rate cuts and some innovative policy initiatives demonstrate this.

However, the markets remain sceptical about whether such policy can really work, and it is evident that the US housing market will take some time to fix itself, with the number of unsold houses still very large. Our research also suggests that the impact on consumption of falling house prices, as households tighten their belts, could prove more powerful than in the past.

All this means that policymakers cannot afford to take a “wait and see” approach. Policy needs to be strategic and forceful enough to deal with the problems ahead, rather than just being focused on tactical measures. US fiscal policy initiatives will deliver an extra $10bn to US households in May and June, about two-thirds of which will be spent in the next two quarters.

But if the spending is to provide a long-term boost for the economy, it must be complemented with effective moves to resurrect the US housing market. Various initiatives here are under discussion, but it could be some months before a clear approach is agreed on.

Market volatility will therefore continue for some time, perhaps prompted by weak first-quarter results from US investment banks and the sale of Bear Stearns to its rival JP Morgan for a knockdown price.

But we continue to think that the markets will eventually be convinced by policy makers’ actions, and will recover – although we cannot predict exactly when the market will reach a trough. Although a prolonged US recession cannot be entirely ruled out, the risks of this are very small and we believe that the US economy will start growing again in the second half of this year.

So, while we may not be at the bottom of the market quite yet, some attractive opportunities are already opening up in certain asset classes, particularly for investors who are not too risk-averse.

However, those investors who are unsettled by the ongoing turbulence may prefer to sit on the sidelines until fundamentals once again hold the ascendancy over fear.

Andrew Miller is head of the Newcastle office of Barclays Wealth

We believe that the US economy will start growing again in the second half of this year