Huge opportunities for those who take longer-term view
Global economy remains stronger than in any previous downturn
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The credit crunch and its effect on the markets have provided a stern test of the resolve of investors.
Yet short-term market volatility presents sound medium-to-long-term investment opportunities if you are bold enough to take them.
First, let us look at what has been happening.
A credit crunch can be a sudden reduction in the availability of loans or an increase in the cost of obtaining a loan from banks.
It can be caused by a sustained period of relaxed and inappropriate lending, leading to bad debts and losses for lending institutions and investors in debt.
The current credit crunch has been caused by the fall-out from the sub-prime mortgage crisis in America. Sub-prime mortgages are loans to people who do not qualify for the best interest rates or normal loan terms due to their credit rating, employment status or the type of asset taken as security.
As interest rates rose, repayment costs escalated and US house prices fell, large numbers of people defaulted.
As a result, major American sub-prime lenders found themselves in big trouble.
Traditionally, banks have financed their mortgage lending mainly through deposits received, which limited the amount of lending they could provide. But this changed in recent years, with banks packaging their mortgage books and selling them on to other financial institutions.
While this has made it easier to fund additional lending, it has hidden the suspect quality of some of that debt.
As this situation has become clearer, so the credit crunch has worsened as banks have become increasingly reluctant to lend to each other, companies and individuals.
All this, along with fears of a sharp slowdown in the American economy, has knocked the markets, created uncertainty and clouded the short-term outlook.
Individual and corporate investors have lost confidence generally.
Industry is finding it more difficult to borrow money to fund development and expansion, and the reduced availability of money to support mergers and acquisitions has further put a brake on world markets.
All these factors have generated a big rise in risk aversion, with everyone reducing spending and looking to reduce debt.
There is, however, a keen sense that market valuations are increasingly compelling in a number of sectors, providing huge opportunities for those investors who like to take a medium and longer-term view.
The world economy is stronger than in many previous downturns and is likely to continue to grow, driven by the increasingly significant emerging economies of China, India and Russia.
The message to investors has to be not to panic or capitulate and to recognise that, as in the past, so-called “bear” markets like these represent a buying opportunity.
The history of the financial markets has shown consistently that a calm, measured long-term view is always the best position to take when investing. Investments should be regarded as long-term commitments, and investors should try hard not to be disconcerted by short-term fluctuations.
In any investment strategy, only two prices matter: the price at which you buy and the price at which you sell.
What happens in between does not matter and you should try to ignore it.
Regular saving as part of a long-term investment strategy offers a flexible, affordable solution for many investors. And, by keeping some wealth in more liquid assets such as cash, deposits or short-term government securities, investors should not be forced into cashing in investments during periods of market uncertainty.
Nobody can say with 100% confidence exactly when is the best time to invest in the stock market, and investors should always try to make sure they don’t have all their eggs in one basket.
But, although a downturn in the markets will mean a more conservative growth, it should be regarded as an ideal time to invest.
The investor should always be thinking of diversifying, and stocks and shares are only one type of investment. Others include fixed interest, property and cash or deposit-based accounts.
As ever in these matters, unless you are a highly experienced investor, there is no substitute for professional advice in the range of investment opportunities available before committing yourself.
Steven McKnight is a senior partner with St. James’s Place Wealth Management in Aberdeen and can be contacted on 01224 202400 or e-mailed at steven. mcknight@sjpp.co.uk
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