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Cloudy days

Phew, what a week. As share prices approached freefall last week, it seemed the message that problems in credit markets could spill over into equities had finally struck home. Not that the real pain lasted for too long. Still, it was a reminder that shares can fall as well as rise.

The subsequent bounce and seesawing that characterised the following week’s trading demonstrated that there were many agents at work in the market. First-half results were beginning to emerge and generally painted a benign picture. Interest rates may be higher and inflation stirring again as a potential spectre at the ball but corporate life remains on the up. Of course, life is never so simple that no clouds are lurking on the horizon but figures from the multinationals are giving sustenance to the bulls.

It seems the global economy is in good shape and those forecasting a longer period of robust growth than previously expected appear to be having their optimism reinforced by the fundamentals. This is not to say a serious upset originating in the credit markets will not have an effect, though.

Where pain becomes visible is often the sign that the condition is fatal. The bailing out of a German bank and fire sale of hedge fund assets demonstrates that these packaged loans have ended up in some unlikely places. So far, no major investing institution has had to admit to over-exposure to these riskier debt assets but the day is young and we should not expect recent volatility to settle down any time soon.

If a week is a long time in politics, it can amount to a lifetime in the market. The week beginning October 19, 1987 changed the landscape for the investment community. Twenty years on and we are still learning that new technology and new practices can result in some unforecastable consequences when conditions change. What we do appear to be getting better at, however, is handling these potential crises in a more timely fashion.

There is clearly a two-way pull in markets. In the blue corner (share prices, for those of you who have never worked on a trading floor, are marked up in blue and down in red) sit those who believe the boom in the global economy will be stronger and last longer than expected. In the red corner are the bears who believe derivatives are weapons of mass financial destruction and collateral damage from the likes of the sub-prime debacle will pull us all under yet.

I sit somewhere in the middle. For some time I have been cautioning that bull markets do not run unchecked indefinitely and that shares have been shrugging off the chaos in credit markets too easily. The recent rise in share price volatility suggests the penny has finally dropped but this is not to say the game is over. Aside from the ripples spreading out from those unwise enough to have bet the farm on extravagant returns from poor quality loans, most of the news remains supportive of continuing prosperity driven by globalisation and the benefits of free (well, mostly) trade.

The collapse of the Soviet Union and entry of China into the World Trade Organisation at the end of 2001 have allowed the prosperity enjoyed by the developed world in the post-World War Two rebuilding period to spill over into those emerging nations. More important, they have vast populations.

I would not discount the problems that may yet emerge in credit markets but I feel more inclined to buy on bad days than join the rush for the exit. We have not yet seen a real correction in this bull market. The gains made since the start of the year were largely handed back in a tumultuous trading week but the overall fall was less than 10 per cent – generally accepted as the minimum for a true bull market correction. Expect more bad days and continuation of volatile conditions but equities should remain the asset class of choice.

Brian Tora (brian.tora@centaur.co.uk) is principal of The Tora Partnership

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