David Budworth
INVESTORS were warned last week that there could be more volatility in the short term despite shares staging their sharpest rally for four years on Friday.
British stocks soared 205 points after America’s Federal Reserve cut one of its key interest rates in an attempt to calm the turmoil that has wiped billions off global stock markets over the past month.
The FTSE 100 index of Britain’s largest companies finished the week 26 points, or 0.4%, higher at 6,064, reversing huge losses earlier in the week.
The Fed slashed the discount interest rate at which it lends to banks by half a percentage point to 5.75%. It kept its main Fed fund rate, which affects mortgage borrowing, on hold at 5.25%, but investors hope this will be next next, providing a fillip for the US housing market at the centre of the crisis.
To help you decide whether the time is right to move back into shares we present the views of two of Britain’s leading investors.
BUY
Teun Draaisma
Morgan Stanley strategist
JUST before the markets peaked in early June, Teun Draaisma at investment bank Morgan Stanley issued – with uncanny accuracy – a triple sell signal.
It was the first time all three warning signs had flashed red since the dotcom bust, and prompted Draaisma to urge investors to slash their exposure to the stock market.
However, he now believes the current storm will blow over and has been urging investors to start buying shares again. Here he explains why: “The model we use to forecast economic slumps suggests we would need three more interest-rate hikes in America to trigger a recession – and that is not likely to happen.
“The fundamental outlook for the global economy remains good, though we are likely to see growth slow in America and the UK. Besides, the rest of the world is acting as the growth engine these days and Europe and Asia are likely to remain robust.
“Good global growth should underpin corporate profits and allow companies to continue to pay good dividends.
“Company balance sheets are very strong and few have significant debt burdens, which will help underpin a stock-market revival.
“Share valuations are also attractive. The price to earnings ratio on the UK stock market is now 12, its lowest level since 1991, when interest rates were double what they are today.
“In the medium term – and when the current turbulence abates – we expect to see a resurgence in takeover activity, led by businesses themselves rather than private equity. That should give a boost to sentiment.
“We also expect to see Asian countries such as China start to switch their savings and currency reserves out of US bonds and into global equities. This will create a very large new buyer for stocks.
“Of course, there are risks. Financial crises often require authorities to intervene to stabi-lise markets and history suggests central bank intervention, such as the Fed cutting US rates, usually marks the bottom of the correction.
“Sure, we may be too early. Markets hate uncertainty and there is a lot of it around. We do not know who owns what financial instrument and who sits on how big a loss.
“But one has to buy at the moment of maximum uncertainty, and we think valuations and sentiment have already taken account of the risks.
“The stock market spends most of its time veering between greed and fear. The best time to buy is when everyone else is worried – and that time is now.”
SELL
Ian Rushbrook of Personal Assets trust
Ian Rushbrook claims that the stock market is overvalued by about 25% – so needs to fall to about 4,500 before it starts to look cheap. He is so convinced that about 60% of the portfolio is in fixed interest and cash. Here he explains why there is worse to come.
“We have a huge credit bubble. Debt has been piled on top of ever more debt. Has the Federal Reserve been keeping the banking sector in check? Far from it.
“Both have been colluding, irrespective of future costs, to keep expanding the amount of loans lent to individuals and companies. US household mortgages in issue now amount to over $10,000 billion (£5,000 billion), dwarfing the US government bond market. The more that debt expands, the higher the risks.
“American sub-prime mortgages, so-called Ninja loans – no income, no job or assets – were irresistible to borrowers and lenders. But as homeowners have started to default the consequences of this lax lending has hit home with a vengeance.
“While sub-prime is a small part of the overall market for mortgages in the US, the way the debt was sold on to investors has given the crisis global significance. The US banking sector packaged the loans into mort-gage-backed securities known as CDOs (collateralised debt obligations). These were sold on to hedge funds and other investment banks desperate for high yields.
“If the US banking system sustains actual losses of around $100 billion, as some estimates suggest, then the implications will be enormous. Banks globally will have to reduce their lending by up to $1,200 billion, causing a debt crunch. Last month’s failure of the two Bear Stearns hedge funds will be duplicated and markets will fall further.
“As bank lending dries up, this will havea huge impact on private-equity deals which have helped to boost share prices. Many buy-outs will prove impossible to finance. It is going to take three or four months for these problems to percolate through.
“There is a further threat to the world’s financial system – the yen carry trade. Hedge funds have been taking advantage of extremely cheap borrowing in yen and investing in high-yielding securities such as CDOs. If the value of these assets is permanently impaired, then there is a serious risk that hedge funds will rush to sell them and the carry trade will unwind.
“This will cause the yen to surge, which will trigger more selling – this already seems to be happening as the yen strengthened 3% against the dollar last week.”
What to do if you’re a bull or bear
MOST market commentators believe the underlying outlook for the economy and corporate profits is sound – so the recent falls could be a good buying opportunity if you are prepared to ride out more turbulence.
Some of Britain’s best investors have been quietly using the turmoil to snap up stocks on the cheap. Anthony Bolton, manager of Fidelity UK Special Situations, is looking to top up his holdings in some of the UK’s biggest companies, which include Vodafone, Reed Elsevier and Glaxo Smith Kline.
He said: “If investors hold firm and persevere, history shows that they will be rewarded. I remain cautious in the short term, but choppy markets can present opportunities for investors like myself to top up holdings on a selective basis, particularly given the general strength of corporate balance sheets and some attractive valuations.”
Neil Woodford, manager of the Invesco Perpetual Income fund, has also been buying, loading up on BG, British Energy, Rolls Royce and ICI.
So what should I buy if I’m a bull?
Graham Neale of Killik & Co, the stockbroker, said: “We have been adding to our positions in bigger stocks on a selective basis, particularly those with good yields backed by assets.”
He likes Land Securities, which trades at a 25% discount to its net assets and yields 3%, and Tate & Lyle, paying 4%.
Some are looking further afield. Dan Kemp of Williams de Broe said: “We increased the amount of our clients’ portfolios in equities as the falls presented a good opportunity to invest, but it is difficult to get in at the very bottom.
“We bought into Japan and Europe; Japan because we think the yen will strengthen and companies at the smaller end look good value, and Europe because there has been a fundamental change in the economic outlook which makes company valuations look good value.”
He likes JO Hambro Japan Equity Capital Management and Atlantis Japan Growth.
I’m not brave enough to buy. What should I do?
Sit tight. Advisers say that if you have a balanced portfolio and are investing for at least five years, you should ride out the storm. Cautious managed funds, which give you a balanced portfolio within one scheme, have dropped an average of 4% over the past month compared with a fall of 9% for the Footsie.
And while UK shares are down 3% this year and up by the same amount over 12 months, you are probably still sitting on sizeable profits over three and five years: the Footsie is up 39% and 40% respectively over that period.
And what if I’m an out and out bear?
Investors are normally advised to buy corporate bonds when markets are in trouble. These are loans to companies that pay a fixed amount of interest, and are seen as a safe haven.
Some analysts are bearish on bonds in case the credit crunch in the sub-prime market infects higher-quality corporate debt. However, Justin Urquart Stewart would still buy them. He said: “If I were a bear, I would also be buying commercial property in the Far East, especially because sterling is likely to weaken against Asian currencies. I would also diversify into timber and gold.”
Ishares offers an exchange traded fund that tracks property in Asia. For access to forestry try the Cambium Global Timberland and Phaunos Timber funds, and to get into gold there is the Merrill Lynch Gold & General or a gold exchange-traded fund
