Credit fears send shock waves through markets

Only a week ago, Jeremy Tigue, manager of the £2.6 billion Foreign & Colonial Investment Trust, highlighted that the "cards are stacked towards a further correction."

Given the sharp sell-off in markets today, as credit fears panic investors, we thought we should provide you with an update on what is happening from Paul Niven, Head of Asset Allocation, at F&C Investments.

Paul Niven, Head of Asset Allocation at F&C, comments: "Over recent days, financial markets have experienced significant volatility, with equity markets bearing the brunt of de-risking by market participants. Central banks globally, including the US Federal Reserve and the European Central Bank have been boosting liquidity in the banking system in order to prevent seizure in the global money markets.

"Such scale of moves were last seen in the aftermath of September 2001 and the action follows signs that the crisis emanating from the sub prime lending carnage in the US is spreading throughout the financial system. Recent days have seen both rumour and confirmation of widespread losses amongst investors, particularly hedge funds, and the decision by many to close the window for investors to exit loss-making funds has led to panic over the breadth and depth of the problem. This has culminated in banks ramping up the overnight rates which are charged to each other for loans due to mistrust and uncertainty over creditworthiness of even the biggest financial institutions. Overnight rates, which typically deviate by a few hundredths of a percent against local base rates have shot up to abnormally high spreads (0.5-0.6%) above base rates. This scale of move reflects material risk aversion and has threatened the smooth running of the financial system. The swift intervention by central banks in adding liquidity is aimed to restore normality to lending rates and prevent seizure in the smooth operation of credit markets.

"Current events have rings of 1998, where systemic risks, related to hedge fund losses threatened to bring global financial markets to their knees. Then, as now, central banks acted decisively, then by cutting interest rates. Now, as almost a decade ago, there is great uncertainty as to how far risks are spread within the financial system and exactly where the losses reside. The market is trading on fear and financials are bearing the brunt of losses.

"During periods such as this, investors cannot afford to be complacent. The simple fact is that subprime related concerns are, and will continue to, dominate market anxiety. Beyond short term volatility, however, the fact that market sentiment right now is so dire presents an interesting opportunity. We are mindful of the risks of a broader based systemic crisis but view the most likely outturn as somewhat less dramatic. There will be ongoing financial problems and many hedge funds are in the process of going to the wall. From a fundamental perspective, however, the outlook for equity markets is still reasonable and, for the patient investor, is good. We believe that market valuations are now attractive, corporate fundamentals are, in general, sound, and take comfort from the fact that corporate earnings are continuing to surprise positively. Our belief that the current episode will not pull the global economy into a downward spiral (and that central banks will continue to provide liquidity as required) suggests that the extreme moves in volatility and sentiment create an opportunity. We may well see some further downside in equity markets in coming days and weeks but upside risks to the end of the year, from current levels, lead to interest in adding to equity positions at current levels."