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Comb the wreckage

Freddie Mac, Fannie Mae, Lehman Brothers and AIG have combined to whip up a perfect storm which has howled on to UK shores over two unbelievable weeks. In the eye of the storm, the FTSE 100 closed below 5,000 points for the first time in three years and the UK’s biggest lender, HBOS, was rescued by rival Lloyds TSB.

Wall Street’s crisis matters to UK investors for many reasons. First, Lehman Brothers reminded investors that it is possible both for equity and bondholders to lose most of their money from a respectable institution. The consequence of this, aside from the losses, is that it will be more difficult for all companies but especially banks to raise capital in the future.
The Federal Reserve declined to assist Lehman Brothers but judged that Freddie, Fannie and AIG were too big to fall. The US treasury department is making some very tough calls and the Bank of England will be watching closely.
Now commodity prices are falling from their highs, their influence has immediately waned. The contest is now between the weak financial system and concerns of slowing growth. This new worry has heaped further uncertainty on investors whose tolerance to bad news is now very low. Pressure on the Bank of England to cut interest rates is now intense as inflation hits 4.7 per cent against the target 2 per cent. The monetary policy committee is divided. Committee member David Blanchflower believes that inflation will “plummet like a stone”. With the drop in oil prices, input prices have begun to fall and the economy has ground to a halt. The belief is that the longer the bank leaves the decision to cut, the deeper the cuts will need to be. Consumers are battling on many fronts and companies with a high exposure to the UK consumer will find the coming months very difficult. At this moment, there is very little on the surface to be cheerful about but investors who are prepared to scratch the surface may find the long-term outlook for UK shares more promising. Grim though the outlook is for UK plc, London-listed companies rely heavily on overseas trade. More than one-fifth of FTSE 100 firms derive at least 90 per cent of their sales outside the UK. Many are still in a position to improve their earnings by tapping the exciting emerging markets growth story, especially in China. The long-term growth story in China, with its growing consumer classes and huge infrastructure spending, remains unchanged despite the drama on Wall Street. Yes, growth estimates have been revised down and there is a degree of dependence on exports to embattled Western consumers but Chinese authorities are determined that its progress as an economic superpower will not be halted and have begun to ease monetary policy to ensure this. Now we are in the eye of the storm, earnings’ growth potential is available at very good value. BP, for example, has a solid balance sheet and having fallen by 27 per cent from its May peak, offers a dividend yield of 5.5 per cent. Strong, desirable UK brands also benefit from growth in emerging markets. Diageo sells many famous whisky brands and is growing sales in emerging markets. Investors would do well to avoid investments exposed to short-term uncertainty, focusing on long-term certainties. How Lehman will unwind is unclear. Will it be orderly or disorderly, who else is exposed, by how much, will asset prices fall as a result of forced selling, will other institutions fall and, if so, which? And the certainties? Nothing is certain but while some commodity prices have fallen in recent weeks, it is unlikely they will collapse to the levels of five years ago. The support for their rising prices remains in the massive growth in consumer demand and infrastructure in emerging markets. Such global growth opportunities are available through the “international” UK market and a position backed by hundreds of millions of emerging consumers seems more comfortable than a bet on which are the last banks standing. Tom Ewing is portfolio manager of Fidelity UK growth fund

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