The Analyst: The good times will return eventually
Saturday 30 August 2008
We are now a year into the credit crunch, but I suspect many people in the UK are only hearing about it now. At this stage it might be useful to look at how we got into this mess.
The irony is that the seeds of the credit crunch were sown during a long period of economic growth and stability, which began in the early 1990s. The UK was well placed to be a major beneficiary after we gained freedom from ERM in 1992, and we thrived throughout a long spell of globally low inflation.
However, this stability lulled people into a false sense of security. Gordon Brown's claim to have abolished boom-and-bust would be funny now if the consequences weren't so serious. Our government has effectively maxed out the nation's credit cards, but they weren't the only ones living beyond their means. The banks egged on a property boom and consumers lapped it all up; now everyone is feeling the pinch.
It seems to me that banks periodically misprice risk, in other words they are far too complacent. The average mortgage for a first-time buyer in 1997 was 2.3 times income at a value of £41,800, but by 2007 that had grown to 3.36 times income on an average mortgage of £116,820. Banks had responded to a strong economic climate by making it easier for people to get loans, but worse was to come.
Just when house prices were reaching their zenith, the banks and building societies increased available loans to a staggering six times income. The banks are now reaping what they sowed. So fragile have they become that they are extremely reluctant to lend money to each other, let alone to the man in the street. Consequently, for the first time in ages, consumers are suddenly finding that credit is no longer available. Time will eventually heal the problems, but it may take some years – the public, corporations and government will have to stop spending and start repaying debt.
So what might the future hold? The inflation we have today is due mainly to global influences that are now beginning to dissipate. Falling asset prices and the repayment of debt are significant deflationary factors, so I believe inflation, and interest rates, will fall sharply next year. However, don't expect this to translate into an instant housing market uplift – credit will remain scarce. The good times will come back eventually, but until then we will have to endure a long and difficult hangover for the economy.
Stock markets are somewhat different because they try to anticipate what will happen a year or two down the line. As a consequence of this, the stock market will bottom out before the economy. This is a crucial point that many investors do not appreciate; if you wait for the economic news to improve before buying into the market then you will already have missed a large chunk of the gains.
The crucial question is: when will the market reach the bottom? I can't pretend to know for certain, but it could happen over the next few months. Things will start looking up once the market feels that inflation will slow and therefore interest rates can fall; as I said earlier, I believe this milestone is in sight.
Two especially interesting opportunities are a couple of corporate bond funds: M&G Optimal Income and Artemis Strategic Bond. They have the flexible mandates and skilled managers to make the best of the opportunities in a changing fixed interest market.
Knowing what to do with equities is a tough job at present, so leave it to the experts. Philip Gibbs is one of the very best and is currently very defensively positioned in his Jupiter Financial Opportunities Fund. Another top manager is Neil Woodford, who runs the Invesco Perpetual Income Fund, and has the confidence and experience to take a truly long term view of markets. I'd back either of them to make sound decisions and navigate investors through these turbulent waters.
Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent
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