The most important reality we have learned in recent months is that there is no quick fix to the pro...
The most important reality we have learned in recent months is that there is no quick fix to the protracted credit crisis. At the beginning of 2008, many expected a tough year with some recovery as we approached 2009. The sheer magnitude of the ensuing fallout was not fully anticipated and any hopes of a return to normality by the end of the year have disappeared.
The markets have been left reeling as seemingly indestructible US institutions like Bear Stearns, Lehmans, Merrill Lynch and AIG fell victim to unprecedented conditions, while some of the UK's largest banks have had to raise new equity or will become consolidation targets.
In place of the anticipated recovery, as we approach the end of the year the markets (particularly financials) are in turmoil, with continental Europe and the UK facing recession while the US struggles to escape the same fate.
The US government bailouts of some of their largest financial institutions have been viewed by many as welcome proactive measures to stabilise the financial system and address systemic risk, perhaps even kick-starting a recovery. However, any ensuing market rally after each such action has been short-lived with a quick return to volatility.
The biggest driver of the chaos is the downfall of mortgages and house prices. Mix in negative economic factors - the credit crisis, global economic slowdown and inflation - with increasingly negative credit market sentiment - rising default rates, slower demand - and we have risk aversion with many, in particular corporates, feeling the pinch.
Despite all of this, there are still opportunities, especially for long-term 'buy and hold' investors. If the timeframe is longer than a year then opportunities remain; however, where an investor's horizon is limited to a few months the outlook becomes more uncertain. Investors should look at each security on its own merit, regardless of situation and classification, to identify risk and unearth the good from the bad.
The old adage 'one step forward, two steps back' aptly describes the credit market, and faith in its resilience continues to waver. While we await the full consequences of the Lehman Brothers collapse, the market has been dealing with news that another large US depositary, Washington Mutual, faces an uncertain future. (It collapsed a few days later.) In our view, when stabilisation in house prices returns, this will filter through to mortgage-backed securities and in turn trickle down into the rest of the market.
It will take time for normality and trust to return, but this is entirely achievable. Overall, we remain cautious as there are still headwinds, but recognise there still exist individual opportunities that are being lost in the panic.
- Credit markets are in a 'one step forward, two steps back' cycle;
- Central government action to stabilise markets has so far proved inconclusive;
- Investors should look at each security on its own merits.
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