Market commentary September 2007

SUMMARY. Of course it is possible that this summer’s drama could turn from black comedy to horror, but contrarians will be hugely encouraged by the news that institutional pension funds (who typically get it wrong) have their lowest weighting ever invested in the stockmarket.
 
The key players in the summer’s unfolding drama are clear, bankers with flakey lending standards and hedge fund managers who borrowed against assets of doubtful provenance.
 
Apparently a quarter of all hedge funds trade based on mathematical models, and this is meant to be the safe end of the hedge fund spectrum.  Goldman Sachs (who pumped $3 billion into one of their hedge funds to rescue it) said this recent volatility represented a one-in-100,000 year event.  Yet anyone that lives in the real world probably recognises that this level of volatility occurs every 5-10 years. 
 
We need not feel too much sympathy with those whose multi-million pound bonuses are at risk, and the impact on the real economy from these players will be limited.
 
The other key player is the US ninja (no income, no job, no assets) who was persuaded to take out a mortgage on an inflated house value.  House prices in the US have now been falling for seven months (this is nothing to do with problems for financial institutions in August) and a debate is raging as to the extent to which this will depress US growth in 2008.
 
As we touched on a few months ago, parallel (though perhaps not as extreme) concerns are now being raised in Ireland and Spain, where house prices are also falling.
 
The key for economic growth in the EU and US is the extent to which the malaise of a limited number of struggling borrowers will infect the confidence of the broader populace.
 
It is easy to envisage the drama unfolding into more of a horror than a black comedy (for those that have stayed calm in recent weeks surely the overwhelming sentiment has been schadenfreude rather than fear!).  But it is always so, and you benefit from the superior long term returns of the stockmarket precisely because you take on unknown risks (which cannot neatly be mathematically modelled, and anticipated, as some would have you believe).  
 
We have previously highlighted the good value in stockmarkets.  The most encouraging news of the last week is that institutional pension funds (that typically get their asset allocations wrong) have their lowest level ever in equities –indicators to buy the stockmarket don’t come much better!
 
Do expect more volatility across all asset classes (including the stockmarket) in the short term, accompanied by more hysterical media reporting, but don’t try and be too clever in trying to catch the bottom – focus on longer term value.