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Seven pillars of wisdom

Chris Salih says last week’s market falls have split fund managers between those who believe there is more bad news to come and those who see buying opportunities amid the chaos

Still the markets ride the waves of uncertainty. Last week was not all doom and gloom, however. Inflation figures were better than expected but with Wall Street still rocked by upsets in the housing and debt markets, it was too easy to dismiss the good news as a short-term blip.

Surely we can take comfort from declining inflationary pressures? It will depend on the next set of figures. Rising demand from an increasingly affluent developing world is not going away. The risk also remains in the UK that the floods and an embryonic foot and mouth outbreak will force food prices higher.

Perhaps the inflation story is not reversing – yet. It will if economic activity really slows but that depends on central banks holding their nerve and maintaining a tight monetary stance. There was no sign of that the other week as they pumped billions into the system to head off the approaching credit crunch.

I am indebted to a number of worthy commentators who have contributed to my growing understanding of what is assailing markets. One particularly learned scribe made reference to the late Hyman Minsky, who taught at Berkeley. It appears that financial markets have their seven ages, much as man.

First comes displacement, an event that changes perceptions, then we see rising prices in the asset class affected. Third, credit eases and financial innovation widens the market for investors. Over-trading follows in fourth place, to be followed by euphoria as those warning of a collapse are swept aside by the reality of what is actually happening. In the sixth age, those in the know quietly withdraw as they recognise the game is over.

So we reach the seventh age – or revulsion. This need not start at the top of the asset price cycle. The insider selling that characterises the sixth age will already have taken the shine off the asset in question but this is when the exits are jammed with those seeking to flee.

Wide and irrational swings in the pricing of credit risk suggest we are in the seventh age but this applies to just one asset class. Does revulsion over the extent to which we have been prepared to lend unwisely and, worse, trade this lending as if it is gilt-edged have implications for economic activity or equity prices? This is a more difficult call but the behaviour of share markets suggests there is more connectivity than we believed.

The same article by economist Martin Wolf referred to so-called “stupid money”. When the phrase was coined by Walter Bagehot, a 19th Century essayist who went on to edit The Economist, he envisaged three stages of a market cycle – plethora, when money is looking for a home, speculation, when it finds it, and panic, when it has been devoured. This appears to be the source of the problem today – too much money seeking a home, much of it borrowed at interest rates that are no longer available. We may be in the final stage of the game but how long it will run is anybody’s guess. For the brave, opportunities may be arising. For the rest, it is tin hat time.

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

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