A great opportunity to buy shares

A great opportunity to buy shares - F&C's Jeremy Tigue, says: Every day I read comments that market conditions are the most turbulent ever and that the current problems are unprecedented.

I do not think that is the case. Things are bad and there is a huge amount of uncertainty but there have been equally bad patches in markets before which have been the starting points of some very good returns for investors.

Past market crises have usually been more intense than the volatility we are experiencing now. Share prices have fallen quickly, as on Black Monday in October 1987, and recovered quickly, as happened after Black Wednesday in September 1992. What we are experiencing now is a more drawn out period of volatility. This is unusual but not exceptional; volatility was also very high in the dotcom boom at the end of the 1990s but when share prices are going up nobody is very worried by volatility.

The crucial difference between the current market turbulence and previous bear markets is that this time around, the equity market is peripheral to the main problem rather than central to it. This time around the problems are in banks and in credit markets as a result of poor lending decisions, poor risk controls and poor design of many credit products. Equities are suffering collateral damage, some of it very nasty, but they are not the source of the problem. This is in sharp contrast to the bursting of the dotcom bubble in 2000 when equities were at the centre of the problem as the share prices of technology, media and telecoms companies had lost touch with reality.

Share prices will not be able to make progress until there are clear signs that the problems that have caused mayhem in the credit markets and undermined confidence in banks are starting to be solved. I think there are two key components in this solution.

The first is a reduction in interest rates. Here, the US Federal Reserve has led the way but the Bank of England and the European Central Bank have been much more cautious. They have been more worried than their US counterparts about inflation and are reluctant to move until they can be sure the inflation rate is falling back. Interest rates need to fall to reduce the burden of debt servicing, so avoiding customers and companies having to pull in their horns in order to cope with their debts.

Cutting interests rates is easy. The second task, restoring confidence in the banking system, is much more difficult. We saw this first with the problems at Northern Rock and the failure to find any solution apart from nationalisation. This month we have seen a run on the US investment bank, Bear Stearns, rapidly followed by its fire sale to a stronger bank and rumours about the major UK bank, HBOS. All of these are indications of a lack of confidence in banks. Central banks need to find a way of restoring this confidence if they want the cuts in interest rates to have any effect. At the moment cuts in official rates are not being passed on in full as banks and other financial institutions are hoarding cash in fear of what might happen next. This causes a vicious spiral of falling confidence leading to fewer loans which lead to falling asset prices which undermines confidence even further.

The way that the Federal Reserve responded to the problems at Bear Stearns showed a determination to use new measures to improve confidence. This is a very encouraging sign for equity markets. If the banking and credit markets start to function again the US economy should be able to avoid a recession. If that is the case most companies look very good value on any historical measure and there is likely to be a sharp rally in share prices.

The excitement in markets has overshadowed just how cheap share prices are. The FTSE100 Index is back at levels it first reached in February 1998. The historic price/ earnings ratio is under 11 compared with almost 30 at the peak of the market in 2000. The dividend yield is higher than it was at the bottom of the market in 2003 and higher than it has been at any time since 1996. The index yield is only just below the yield on ten year gilts, and equities have yielded less than gilts since 1959. Only by predicting a general collapse in profits and a significant number of dividend cuts can the numbers be made to look anything other than very attractive on a long term view.

My strong belief is that the first half of 2008 is a great opportunity to buy shares.