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Investment View: Playing the waiting game

Last week was eventful in the world of investment. First, there was the collapse of Refco – hardly a household name but an important player nonetheless.

It was no mean operator in the derivatives market, with an estimated involvement that exceeded $4,000bn a year. Yet the real casualties are the lending banks and Refco’s counter-parties and stock and share holders. With the secur-ities industry more alert to systemic risk these days, any knock-on effect is likely to be limited.

Then we had inflation figures and the publication of the Bank of England’s minutes for the earlier meeting this month. There was some harmony among committee members, with all nine voting for no change. But this could swing back the other way, with weaker economic statistics supporting a cut in interest rates, made more likely by Sir Andrew Large stepping down. Do not expect much soon, though. Retail sales figures may disappoint but it looks as though interest rates will remain unchanged until 2006.

Justification for holding rates comes from inflation figures, with the CPI posting its fourth straight monthly increase, taking it to the highest level seen since early 1996. But the core measure – this excludes energy, food, drink and tobacco – remained unchan-ged at 1.7 per cent. Moreover, the gap bet-ween the CPI and the retail price index has now narr-owed to 0.2 per cent. This is because housing no longer exerts quite such an influence.

Deciding what should happen to interest rates is tough. On the one hand, higher utility and energy costs is forcing up the cost of living. On the other, the fact that money is being taken out of the pockets of consumers is leading to a cutback in discretionary spending. Given that the consumer has been driving economic growth recently, it can be of little surprise that economic prospects now look more subdued. The MPC may be charged with keeping inflation under control but they must also take economic prospects into account.

Last week saw the 18th anniversary of Black Monday. Unsurprisingly, comparisons were drawn with 1987 when shares in London suffered their biggest one-day fall this year on October 19. Traders, spooked by the prospect of rising inflation on both sides of the Atlantic dumped shares indiscriminately. They need not have been so concerned. The situation 18 years ago was exacerbated by a lack of understanding of how the cash and futures markets interrelated. This was recognised by the authorities and appropriate measures were put in place which is part of the reason why the Refco collapse is of much less significance. Of more significance was the fact that markets had become overbought during preceding mon-ths. Shares were riding for a fall – and fall they certainly did.

Circumstances are different this time. While smaller companies have bounced back from the bear market, market leaders still stand below the levels reached at the end of 1999. Valuation levels are nothing like as exposed and we do not appear to be on the verge of any form of trade or business collapse. If anything the reverse is true.

Investors could be forgiven for sitting on the sidelines until a better trend is establish-ed. That looks to be what the MPC will be doing. Tackle inflation, and they need to put interest rates up. Tackle sliding economic growth, and they need to cut them. Who said that choices were ever easy? Let us see what else emerges as the days shorten.

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