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Long sighted

We are in the midst of the most severe recession since the Great Depression of the 1930s. This follows a long period of excess, where companies and individual consumers became increasingly leveraged. Of particular concern are the mortgage loans made to people who do not have sufficient income to repay these loans (the “sub-prime” loans).

As the assets that they borrowed against have declined in value, many of these borrowers have defaulted on their loans. When you add factors such as mounting job losses, it is easy to understand how sentiment has become so gloomy.

Given the depth of the slowdown and, in particular, the declines in equity markets, concerns have turned to the Great Depression. People frequently ask if we are likely to experience a calamity of that proportion. As the Federal Reserve chairman Ben Bernanke is a student of the Great Depression (along with other policymakers), it seems unlikely that we will see a repetition of key policy mistakes that led to and exacerbated the Depression.

For example, interest rates and taxes were increased in the early 1930s, which is in stark contrast to the unprecedented level of stimulus that the current regime has provided through rate cuts and stimulus packages.

Additionally, there are more social “safety net” features now, which help moderate the impact of a very poor economy. However, this is without question a very difficult situation.

We believe that in February the market reached the maximum point of uncertainty – caused by the combination of a lack of confidence in the authorities, a raft of very weak economic data and negative press in the media. However, there has been a significant rally since March 9 after the US Treasury announced more concrete details of the Public-Private Investment Program.

While the plan is still a work in progress, it was a positive sign of action which the US equity market had desperately been seeking and appears to have stabilised the environment for the moment. While we do not expect the market to go straight up from here, we believe we might have seen signs of a bottom.

There are a few positives starting to emerge from all the recent negativity. The decline in oil prices and mortgage rates has meant that consumers have higher disposable incomes. Additionally, we are seeing an increase in the savings rates by US consumers. Also, company earnings’ estimates for 2009 have reduced significantly to levels that are now more realistic. Finally, valuations have come down across the market and there are compelling investment opportunities in a number of areas.

With all this in mind, we believe the US equity market is likely to be volatile in the next couple of months as the economic downturn is expected to last longer than other recent recessions. However, given the magnitude of the sell-off (second only to the 1929-32 bear market in scale of decline), the market is now attractively valued.

For investors with a two to three-year horizon, we believe there are some excellent investment opportunities to buy stocks with very attractive risk/reward profiles. It is important to take a longer-term view and use market volatility to your advantage.

We are seeing some of the best opportunities that we have seen for over a decade, as over the past 10 years it has been increasingly difficult to find good companies at low valuations. However, as a result of the sell-off, we are now able to add to some great companies at very low prices.

In our experience, these sorts of opportunities usually arise following periods of great uncertainty.

Jenny Jones is manager of the Schroder US mid-cap fund and Schroder US small-cap fund


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