We're all doomed? Don't be swayed by share panic

The worst thing you can do is cut and run, writes Jason Nissé

The phrase "Black Wednesday" has already been used for the day, just over 10 years ago, when the pound was ejected from the European Exchange Rate Mechanism. So last Wednesday's 5 per cent fall on the London stock market, taking the FTSE 100 to an eight-year low, means that the doomsayers have to dream up some new clichés.

And there are a few of them about. "Market apocalypse", "slaughter of the bulls" and "stock exchange mayhem" all crossed the lips of traders and commentators as they ran around like Corporal Jones in a rerun of an episode of Dad's Army. When the likes of Brian Winterflood, the doyen of City traders, popped up on the radio saying he expected the FTSE 100 to fall from its current 3,601 to as low as 2,500, investors could have been forgiven for rushing to hit the "sell" button.

However, calmer voices are pointing out that this is a bear market like no other bear market and there are plenty of reasons to hold tight – especially after the recovery that took place on Thursday and Friday.

First, you have to work out why we are here.

Shares have fallen 50 per cent from their 1999 peak. Admittedly that was during the dot-com boom, and quite a few stocks were clearly overvalued. Subtracting the well-founded corrections to TMT (telecommunications, media and technology) shares could account for anything up to a third of that drop. But that would still leave us with the FTSE 100 above 5,500.

Then you have war fears. These affect at least three areas. The first is oil. When the FTSE hit the basement on Wednesday, the oil price was heading above $38 a barrel, more than twice what it was 18 months ago. As the North Sea does not meet the UK's oil needs, we are an importer of the black stuff and the market is worried about the net cost to Britain, which could be in excess of £10bn this year.

Related to that is the general effect on the economy. City commentators were initially relaxed about this conflict, thinking it would be like the 1991 Gulf War, when all the bad effects were quickly reversed in a bout of post-war euphoria. But in recent weeks pessimism has gripped the City, and growth forecasts are being shaved by as much as 2 per cent for this year. Even allowing for these gloomy predictions, it should be remembered the UK still has the best-performing economy in western Europe.

There's also the political issue. If you have Cabinet ministers on the verge of resigning and the Prime Minister's position being questioned, then the markets get nervous. They do not like political change and fear any replacement for Mr Blair will be much more left wing.

All this is exacerbated by two technical factors. The first has been well publicised. The Financial Services Authority's solvency rules for insurance and life companies have been biased against holding equities: when the market falls, the firms come under pressure to shore up their balance sheet and have to sell shares. After lobbying by the big firms, the FSA relaxed these rules last week, which should mean that the likes of Standard Life, which thinks the market is undervalued, could start buying.

The second issue is the increasing use of derivatives – or futures and options, as they used to be called – by big investors. Warren Buffett, the US financial guru, called derivatives "time bombs" and "financial weapons of mass destruction". He has pointed out that the use of highly complex financial instruments creates risks that many people don't understand, and can accelerate any falls in the market because they enable sellers to load up their bets at relatively little cost to themselves.

However, the reverse is true. If confidence returns, derivatives allow investors to make big bets on a recovering market. So if sentiment turns, the FTSE 100 could rise at least as rapidly as it falls.

Ultimately, it is easy for the small investor to feel overwhelmed. A 50 per cent fall in the market will hit not only direct investments such as individual savings accounts, but also your pension and your endowment. Unless you think the market is in a deathly spiral, the worst thing you can do is to cash in right now, as all you will achieve is to seal in your losses. It's time to be calm like Sergeant Wilson, not panicky like Corporal Jones.