The Jonathan Davis Column The financial crisis may not be as acute as it was but the experts still see cause for caution
AFTER THE panic, now for a brave face on the world. October has come and gone without apparently any further disasters in the financial markets.

The G7 group of countries is busy issuing positive-sounding communiques in an attempt to persuade the world that they are getting to grips with the worst financial crisis since the war.

Short term interest rates are coming down, stock markets have recovered half of the losses they suffered in the middle of the year - and closer to home, Gordon Brown is whistling bravely about our future economic prospects.

It is hard to find anyone who does not think that the economic forecasts in this week's pre-Budget statement are wildly optimistic, but nobody should be surprised that the Chancellor is unwilling to risk making a gloomy outlook gloomier still by slashing his growth forecasts more aggressively.

So is the great financial crisis of 1998 already over? This week I have been taking some soundings of the views of a number of favourite commentators and market participants. Their views - which of course are not conclusive - follow.

In New York, Peter Bernstein, the respected commentator on markets and invest- ment, argues that the hedge funds have unfairly copped the blame for the crisis which erupted in August. Their only sin is to be the most visible victims of a classic market overshoot which has seen too much easy credit made available for investors and lenders alike to bet on increasingly improbable outcomes (a worldwide phenomenon of which the giant stock market bull run is just one symptom).

At a time when even Alan Greenspan has acknowledged that we are entering "a frightening and unstable environment", several risks remain for stock market investors. A resurgence of inflation should not be ruled out, says Bernstein - easy money and a weaker dollar are after all "the raw material of inflation".

But if that threat does not materialise, then the disinflationary pressures which is then implied can only mean that profits will be squeezed - also not good for investors. Bernstein's conclusion: "a rebirth of euphoria is premature".

In the UK, Michael Hughes, for many years the market strategist at BZW, and now a director of Barings Asset Management, sees debt having now replaced inflation as the number one enemy in investors' eyes. He expects what he calls a "price recession" in which continued downward pressure on prices forces business globally to compete aggressively for market share, with economic activity falling in nominal terms, but not necessarily in volume terms.

This is an environment which probably implies a continued outperformance by larger companies with strong brands and market presence at the expense of smaller companies (though he notes that there is a discrepancy between the CBI business confidence index, which is at its lowest level for years, and the fact that directors of companies are buying shares in their own companies in record amounts - which implies a high degree of confidence).

More generally, he thinks investors should remain fully invested, but be diversifying more - as they have been - into bonds to protect against the risk that economic growth does slow down badly.

Stephen Lewis, the bond market watcher at Monument Derivatives, and one of the first to sound the alarm about the deteriorating global financial environment, is also still gloomy. He reckons that the chances of getting the UK economy to a "soft landing" are "close to nil". He thinks that the deterioration in investor psychology - the gathering gloom factor - is likely to drown anything the Bank of England's Monetary Policy Committee can do to try and engineer a controlled slowdown in the UK economy by fiddling with interest rates.

Meanwhile, from Crispin Odey, one of the few hedge fund managers to have come through the current crisis relatively unscathed, comes a warning that the developed world is now being "hit by an old-fashioned credit cycle and not the usual trade cycle". He points out that there have only been two previous occasions this century (1906 and 1954) when US long term interest rates have fallen below the Fed Funds rate, as happened this summer.

"In a world in which Greenspan is flooding the US with credit to offset the credit crunch: in which many investment banks and several European lending banks are dangerously exposed; the stock markets have been desperately trying to cling to their hopes of yesteryear". The market may rally in the short term, Odey thinks, but the bear market in his view has not yet run its course.

The same view is shared by Andrew Smithers, the fund management adviser. His research indicates that the stock market is still badly overvalued and that the next phase of the bear market will be triggered by a collapse in company profits (some signs of which are already being seen in recent trading announcements - witness the dramatic warning about deteriorating business at Marks & Spencer this week).

The economy has been growing above trend for some time now, and so the next direction is likely to be downwards - and sharp, Smithers believes.

It is easy to overdo the dark side of current prospects, but my reading of informed opinion is that it is premature to declare the crisis over yet. The message is not that "the end is nigh", but it remains: proceed with caution. Certainly don't take too much heed of all those cheery official pronouncements. We are not out of the woods yet.