February 28th, 2008 by john
Credit fallout leads to turmoil
After an eventful end to 2007, investors are looking at 2008 with apprehension. The last few months have seen the collapse of the
US sub-prime mortgage market, the credit crunch, and the first “run” on a UK bank for over a century. Speculation over the possible length and severity of the fallout from the credit crunch continues to dominate headlines. Meanwhile, fears of an economic slowdown in the US, coupled with soaring food and energy bills, have compounded the pervading atmosphere of nervousness.
For companies, the credit crunch has led to a sharp increase in the cost of borrowing. Although many companies are in relatively strong financial shape, some – particularly smaller companies – may find tighter credit conditions hard. This could ultimately lead to job losses and higher unemployment figures. On the consumer side, a booming housing market had fuelled confidence, giving UK homeowners, in hindsight, an over-inflated sense of wealth. This, coupled with the availability of easy credit, encouraged many to borrow large sums of money. However, the collapse of the sub-prime mortgage market has stopped the easily available credit and consumers are more wary about their spending. For many UK retailers, the Christmas boom failed to materialise, resulting in downbeat reports and even profits warnings.
This has sent a worrying signal to those already concerned about prospects for economic growth. Sentiment amongst equity investors has taken a further knock. Nevertheless, the corporate environment remains in relatively good shape: it is possible to find well-managed companies with strong balance sheets. However, selectivity and realistic expectations are important during this time of uncertainty.
Looking ahead, investor sentiment is likely to remain fragile and bad news will likely meet with a disproportionate level of disappointment. Investors have good reason to be wary in the short term; however, stock markets tend to be driven not by logic, but by emotional factors such as fear: the key is to stay calm, think long term, and be selective. Astute long-term investors should remain objective and remember that, in the words of Franklin D Roosevelt, “the only thing we have to fear is fear itself”.
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