So, the unthinkable suddenly happened: the world's stock markets peered over the edge of the abyss earlier this week and then, just as suddenly, they returned almost back to where they had been before the panic selling started. Nic Cicutti looks the ways
There was a frightening irony in the sudden collapse of stock markets last week. It came barely days after many self-professed pundits had expressed their serene confidence in the solidity of all the various investment fundamentals.

For a few hours last Tuesday morning that serenity cracked as the FTSE 100 share index dropped 450 points within hours of markets opening for business.

The causes and long-term consequences of the fall are discussed in more detail elsewhere in this section. But for many investors, including millions who suddenly became shareholders after building society demutualisations earlier this summer, plus hundreds of thousands who have poured money into a range of unit and investment trusts, there are a number of important questions that need to be answered.

Is this kind of decline in the value of equities likely to repeat itself, this time on a more permanent basis? Should they be selling up and moving back into safer havens, such as building society accounts?

The experts are unanimous that this would be a mistake. First, as Jeremy Batstone, head of research at NatWest Stockbrokers, points out, even though the market dropped 16 per cent from its peak at one point this week, this was still 10 per cent up on the start of the year, better returns than any building society account.

Second, as Frances Davies, head of pooled funds at Morgan Grenfell Asset Management, argues: "We think today's market conditions are very different from those at the time of the 1987 crash. Cash positions within UK funds are at historically high levels, which should provide support for the market."

A similar picture is painted by Bill Mott, head of equities at Credit Suisse Asset Management: "We believe that it is unlikely the savings-driven market momentum will be dampened. The typical driver of the current market - the Delaware dentist in the US - will not stop saving because of recent events."

A more cautious note emerges from Andy Brunner, group strategist at Aberdeen Asset Managers: "Bullish sentiment has been all pervasive. Valuations are very high by historical standards. The unwinding of the generally perceived overvaluation of markets, plus increased concerns over potential growth rates, warrants a more cautious approach over the next few months."

So, despite the shenanigans of the past week, fresh walls of money will continue to pour into equities, keeping prices up. But what about small investors in the UK?

If you received former building society shares and decided not to sell, one important aspect of the UK market in recent months has been the dramatic rise of financial company share prices which helped inflate those of Halifax, Woolwich, Abbey National and Norwich Union. Selling up now would be a mistake. Treat the shares as free cash and sit on them for a few years.

For those with endowment policies linked to mortgages, the position is lightly different. Unit-linked endowments will follow the stock market's gyrations. But with-profits endowments are different in that once annual bonuses are added to the the policy, they cannot be taken away.

Anyone considering setting up a regular premium investment should carry on as normal. One side-effect of the fall is that every pound invested buys more shares. If they rise again, so does the value of the overall investment, much of it theoretically bought on the cheap. This is called "pound-cost averaging".

Lump sum investors have a harder choice: watching the value of their money plummet within months of placing it in a fund can be a painful experience. It may be sensible to hold off for a few weeks to see where the market stabilises at.

This begs the question of where to put the money. Fund managers argue there are "good buying opportunities" out there, shorthand for: "We will find underpriced funds and make heaps of money out of this, trust us."

That may be the case, but tracker funds, which simply follow share index movements, have shown they can recover just as quickly in a downturn as actively managed funds.

Finally, what parts of the world should one invest in? Keith Niven, chairman of Schroder Unit Trusts, still rates Hong Kong as a strong economy with all the right "fundamentals". But Schroder, with its heavy involvement in that region, would say that. Many other experts are privately suggesting the entire region is "bombed out". If you are of a nervous disposition, stay away.

In the UK, stick to funds that focus on the domestic market, investing in companies which are unlikely to see tail-offs in consumer demand, no matter what happens to the economy.

Which funds? That is harder to call, since many will switch their equity mix. In the coming weeks we will look at what could form part of a more defensive portfolio.

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