THE start of August was an absolute shocker for global financial markets. The US and UK markets were two of the worst affected, although plenty of other markets around the world went into bear territory, including Germany, Brazil and Russia. So why did this happen? And what steps can be taken to protect your finances against these recent events? Many investors are waking up to the fact that a number of the assumptions they’ve been making since March 2009 were really wide of the mark and unlikely to come into fruition any time soon. First, many assumed that the US market would rapidly enter a selfsustaining recovery with a little help from the Federal Reserve. That’s clearly not happened, with it looking increasingly likely that the US economy could even be slipping back into recession rather than moving into recovery territory. Secondly, the government assumed that European politicians would “do whatever it takes” to save the Eurozone in its current format. After the Greek debacle, how could the European Monetary Union fail to put in place measures to protect the rest of its members?
No clear resolution
Unfortunately, this didn’t happen either and no clear resolution has been put forward to date. It is becoming increasingly likely
that the German government is going to have to give a “yes” or “no” answer to the only question that matters for the Eurozone as we know it: “Will you act as the piggy bank for the rest of the other nations?” After all, the money that the European Central Bank (ECB) is using to buy Italian and Spanish bonds has got to
come from somewhere. Overall, it looks like the last chance for European policymakers. The Greek bailout interventions obviously didn’t work, nor did the Irish and Portuguese interventions. Therefore, a radical rethink will be needed to get the Eurozone out of this mess. My personal preference would be for a two-speed Eurozone with two versions of the Euro being used: One for the stronger nations and another for the PIIGS economies and other Euro nations whose economies are simply not strong enough to remain in the Eurozone in its current format.
Concern with China
Another major concern is that many investors thought that, if all else failed, good old China would come to the rescue. Unfortunately, this isn’t panning out the way we had hoped either with China’s rapidly rising inflation continuing to be a concern. At the time of writing, I can see that the consumer price index inflation is around the 6.5% mark. This is much higher than expected and strongly suggests that the Chinese government can’t afford to stop its current policy on interest rate hikes any time soon. In reality, the three global financial issues mentioned above strongly suggest that the “recovery”
from the 2007-08 downturn/recession was premature, and the policymakers are clearly running out of stimulus options to pump up asset prices again. Interest rates in the US, UK and Eurozone are at rock bottom levels and the banks are unable to lend more to consumers due to their new punitive capital adequacy requirements. In addition, whilst governments may not be genuinely reducing developed world public spending, it certainly isn’t growing at the rate it did during the boom times.
Stockpiling cash
In reality, the consumer is still too skint to pick up the slack and spend our way out of this crisis, and companies aren’t keen to invest their spare capital in such uncertain
times, preferring to stockpile their cash reserves instead. So what is the end result? Any policies designed to stimulate global growth are clearly failing. Stocks across the worldwide economy are diving. Bear markets (falls of more than 20%) are now firmly in place in countries from Germany to Russia to Brazil – though not in the UK yet.
Not all doom and gloom
So is it all really doom and gloom? If we look back to 2008 and 2009, when markets crashed, central banks had plenty of room to slash interest rates. Meanwhile, commodity prices dived, bringing the cost of petrol down sharply. As a result – certainly
here in Britain, where plenty of people had home loans tied to the Bank of England rate – many people saw their cost of living fall. Indeed, if you held onto your job and owned a home, things weren’t anywhere near as bad as the papers would have you believe. Unfortunately, it doesn’t appear to be the same this time around. Yes, oil prices are falling, but this has yet to be passed on to the consumer via lower fuel and energy costs. In addition, mortgage rates are already as low as they can go so there’s no chance of any relief from here either.
Further easing
I do remain optimistic about the possibility of further quantitative easing into the UK and US economies. Put simply, QE is the process of giving the banks additional money to inject into the economy. The Bank of England prints money to buy gilts from the banks. However, for QE to be successful the banks then need to take said money and lend it to businesses and the general public rather than injecting it into stocks and commodities. This will increase the money supply and enable the economy to grow its way out of the current crisis. With regards to individual investment and pension portfolios, the view that I have held for quite some time has been to stay defensive and to adjust your portfolio to protect against further market volatility. I would prefer to see holdings in gold, blue-chip stocks and corporate bonds and cash, as these will enable you to weather any further market storms and protect the value you have accumulated to date. Holding cash will also allow you to take advantage of buying opportunities further down the road.
Act with caution
I would, however, act with caution when viewing the current market conditions as the mother of all buying opportunities. If anything, I would suggest you drip-feed money into the markets on a regular basis. Investment studies clearly show that pound cost averaging (drip-feeding money into the markets) is a strategy that benefits from volatile markets.
The more the market swings, the greater the benefit to someone who uses this investment strategy. After all, we are still some way from a full blown recovery and further market swings will be rife until the policymakers come up with a solution to deal with the major issues mentioned above.
