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The bottom line

Economists recently “celebrated” the first birthday of the credit crunch. Markets have been living with it for a while but the public are only now starting to feel its effects.

It seems like 2009 will be the grimmest year for the economy we have seen since the early 1990s. For many people, the shock is that much greater because they never experienced a recession before.

The irony is that the seeds of the credit crunch were sown during a long period of economic growth and stability, which began in the early 1990s. The UK was well placed to be a major beneficiary after we gained freedom from the exchange rate mechanism in 1992 and we thrived throughout a long spell of globally low inflation.

However, this stability lulled people into a false sense of security. Gordon Brown’s claim to have abolished boom and bust would be funny now if the consequences were not so serious.

The Government have effectively maxed out the nation’s credit cards but they were not the only ones living beyond their means. The banks egged on a property boom and consumers lapped it all up. Now everyone is feeling the pinch.

It seems to me that banks periodically misprice risk, in other words, they are far too complacent. The average mortgage for a first-time buyer in 1997 was 2.3 times income at a value of £41,800 but by 2007 that had grown to 3.36 times income on an average mortgage of £116,820. Banks had responded to a strong economic climate by making it easier for people to get loans but worse was to come.

Just when house prices were reaching their zenith, the banks and building societies increased available loans to a staggering six times income. The banks are now reaping what they sowed. So fragile have they become that they are extremely reluctant to lend money to each other, let alone to the man in the street.

Consequently, for the first time in ages, consumers are suddenly finding that credit is no longer available. Time will eventually heal the problems but it may take some years. The public, corporations and the Government will have to stop spending and start repaying debt.

What might the future hold? The inflation we have today is due mainly to global influences which are now starting to dissipate.

Falling asset prices and the repayment of debt are significant deflationary factors so I believe that inflation and interest rates will fall sharply next year.

However, do not expect this to translate into an instant housing market uplift – credit will remain scarce. The good times will come back eventually but until then we will have to endure a long and difficult hangover for the economy.

Stockmarkets, though, are somewhat different because they try to anticipate what will happen a year or two down the line.

As a consequence, the stockmarket will bottom out before the economy. This is a crucial point that many investors do not appreciate. If you wait for the economic news to improve before buying into the market, then you will already have missed a big chunk of the gains.

The crucial question is, when will the market reach the bottom? I cannot pretend to know for certain but it could happen over the next few months.

Things will start looking up once the market feels that inflation will slow and therefore interest rates can fall. As I said earlier, I believe this milestone is in sight.

Two especially interesting opportunities are a couple of corporate bond funds – M&G optimal income and Artemis strategic bond. They have the flexible mandates and skilled managers to make the best of the opportunities in a changing fixed-interest market.

Equities will rally well before the economic news gets better. This is a crucial point to communicate to investors. If you wait for economic “stability” (a word that I often hear investors use), then you will probably miss around 30 per cent of market gains.

Sticking to experienced managers should help your clients reap the rewards in the end.

The hardest part – especially in these markets – is to get them to focus on the long-term potential rather than becoming distracted by the short- term noise.

Mark Dampier is head of research at Hargreaves Lansdown

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Thank you for the music

I write this column – my last among the ranks of intermediaries, at least for now – having seen, praised, criticised and occasionally influenced much of what our industry has done over the last five to 10 years.

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