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Unaccustomed to financial insecurity: the plight of the wealthy Back  
In the second in a series of articles,Se?n ? Murch? looks back at an article written by his Bank of Ireland colleague Mark Cunningham in February 2003 that predicted markets were going to turn in the aftermath of the tech bubble bursting, the Enron affair and 9-11. Within a month of the article being written the bottom of the equity market was reached and gains for investors in real assets stretched to mid 2007. O’Murchu asks whether there is a case of deja vu and if today’s markets are about to turn as they did in 2003.
In February 2003 we published an article in Finance magazine entitled, ‘Unaccustomed to financial insecurity?’ At that time we were reflecting on the changes that had happened in the wealth management industry due to three years of an equity bear market in the aftermath of the tech bubble.

We argued at the time that despite the prevailing doom and gloom, times for investors were going to turn. And turn they did with March ’03 marking the nadir of the equity market, we saw a period of exceptional gains for investors in real assets that stretched to mid 2007.
Seán Ó Murchú

A case of deja vu?
Back in 2003 the cause of the malaise was the long path of recovery needed from the overblown valuations of the late 90’s and the restoration of trust following the accounting scandals. In February of that year, investor confidence was reaching a trough and most investors both private client and institutional were increasingly disenchanted with the prospects for a short term recovery. This time around it is the aftermath of the credit crunch and more recently the rise of inflationary pressures. The cause of each crisis is always new, but what makes all such periods resemble each other so markedly is the rise of investor pessimism. At that point few were prepared to argue for a resurgence in stock markets, despite the compelling valuation argument. The stuttering economic recovery of 2003 was far from inspiring at that point. However we argued that at that point, we’d seen the worst of the bear market by February 2003. Similarly for 2008 we believe that we have seen the worst of the credit crunch and global equity markets have been in a bottoming process since March. In like fashion to 2003, we believe that private investors should be in the market as opposed to being bystanders to a recovery, when it comes to pass. As to whether the rally between March and June was a ‘sucker rally’ I suspect that what we are seeing in recent weeks is this market low being tested across a number of markets. The extent of the market rally from mid March onward lacked the breadth that one might look for in terms of a sustained rally, so we probably haven’t seen markets re-assert in terms of confidence. There will yet be further breaches of the March low in some markets, but in general our view is that we will see markets bouncing off these types of levels for a while yet. If anything, the more recent losses suggest the bottoming process looks quite realistic.

My case for why this will play out is as follows:
Firstly the message has been unequivocal from the world’s monetary authorities – that all available means were to be used to quench the credit crisis. As a consequence we argue that the bulk of the credit crunch has been ‘priced in’, with markets having discounted significant further write downs. Secondly, combining the scale of monetary actions with the US fiscal stimulus, it reads now like the US may bounce off recession – so we may well end up with a bad mid cycle slowdown rather than the shallow recession that was being talked of; either way it no longer looks like a significant downturn stateside. Thirdly, valuations are experiencing new levels and presenting long term investors with one of the cheapest points of entry to equity markets in a generation (better than 2003 did). With this set of variables to deal with one would think the argument over? Well no, private investors are as spooked by inflation as any other investor. With persistent commodity inspired inflation coming into the system, the spectre of analogies with the 1970’s has left many would be investors on the sidelines. As long as we see oil prices spiking and dominating the headlines this psychology will prevail. However, while it is a brave man that predicts when the current oil mania relents, I believe this to be a bubble reminiscent in many ways of the tech days as outlandish daily price movements dominate. While it may be a trite analogy the scale of the rise in the NASDAQ in its bubble phase bears striking resemblance to the scale of the rise in the commodity markets in recent times.

Making the case for the top of a bubble however is next to impossible. Why the longer term trend in many commodity markets may be well supported, it does however look to us more like a cyclical peak and that we’ll see this abate and with it inflationary expectations. The hawkish tones from central banks will persist in the medium term as long as these pressures remain and we will see modest rate responses. Nonetheless, if as I suggest might happen, we see commodity markets and therefore inflationary pressures relent, at that juncture there will be scope for equity markets to do what they haven’t yet done in response to recent monetary stimulus and that is engage in multiple expansion.

The challenges that remain are many, not least of which is the ‘deleveraging’ process that will be in evidence in many western economies for some time to come. In some ways the next while may look in many ways similar to the US S&L crisis and 1990/1991 recession as both borrowers and lenders re-build balance sheets.

Undoubtedly as we see this period begin to heal, a lot of private investors will rest in cash. However it will probably also signal the beginnings of the use of other asset classes and a broadening of the use of more diversified multi-asset portfolios. Amongst this turmoil I believe we will see the use of alternative assets coming to the fore somewhat. Back in 2003, we were allocating to fund of hedge funds and similar vehicles. The appetite amongst private investors since that period has been relatively modest, in part as the appetite for property related investing ballooned. However with a resurgence in volatility levels and such significant dislocations in many capital markets there will most likely be increasing interest once again in the more absolute return style investing.

In many of our client portfolios we’ve been making significant allocations to certain alternative strategies and this has been a key element in our relatively strong fund performances thus far in 2008.

The case for investing in property will be one of selectivity as there is considerable uncertainty right now in how pricing will ultimately be impacted by current conditions. There will undoubtedly be value opportunities but a lot of froth is being blown off the commercial property markets right now and it will take a discerning eye to sort the wheat from the chaff.

The cause of current malaise is different but all crises tend to bear some resemblance when it comes to private investors. In almost all cases confidence and the scale of the opportunity will head in different directions, and perhaps just like 2003, we are reaching that point.

Nonetheless drawing direct analogies with previous crises would be just as flawed and there is little doubt that even a year into the current difficulties, while the long term buying opportunity may well be upon us, it is still well disguised in a fog of volatility.

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