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The ghost in the machine

Our panel debate the impact of the US downgrade on investment strategy, ask if social impact bonds are a case of the Government passing the buck to private investors and agree a market crash is not a foregone conclusion but that bad news is spooking the markets

The panel

Darius McDermott, managing director, Chelsea Financial Services

Adrian Lowcock, senior investment adviser, Bestinvest

Following the extreme market volatility seen in August, some commentators have expressed fears of a sharp downward correction as most of the biggest market crashes, such as Black Wednesday, happen in the autumn. Are you concerned about a market crash in the coming months?

McDermott: I am concerned there is still plenty of bad news out there and what we have seen, particularly recently but also through earlier parts of the year, is that markets get really spooked on bad markets. The FTSE was going between 5,800 and 6,100 and it rapidly broke that barrier and headed straight down to between 4,800 and 4,900.

I would certainly say the chances of a market crash have increased greatly. Do I think it is directly going down? I just do not know but I believe the chances of a significant negative market movement have increased greatly, even though we have already gone down a decent chunk.

Lowcock: October always carries a risk. It is known as Black October, although it does not happen every year.

August is always a bit of a slidey month because it is weak on performance data but what we are seeing at the moment is not necessarily the same as having a sharp downward correction. It is lots of little data points that have fed in badly, combined with genuine concerns over US economic strength and European political direction.

However, something in China could trigger a sharp downward correction. Growth there is soft-landing but if it becomes hard it could knock confidence quite quickly. The figures would have to be very bad though. It all depends on how much you trust the figures coming out of China.

How, if at all, has Standard & Poor’s US downgrade affected your investment outlook?

McDermott: I do not think the US is going to get further downgraded as I do not believe another rating agency would dare after the reaction experienced by S&P.

The downgrade added further bad news fuel to the market fire. Following weak US growth and the continuing annoyance of euro sovereign problems, a US downgrade seemed to be the final part of the puzzle. The three things came together and really sent the market into freefall.
Some think that is now priced in. The way I look at it is not as one issue over another, it is in aggregate and there is still bad news out there.

Lowcock: The downgrade has not significantly affected my outlook. There was a lot of expectation it would happen at some stage and, in reality, it has not had much effect on Treasury yields. People still view the US as a safe haven asset in times of crisis so there is an argument that S&P has just downgraded the risk-free rate.

It is significant in that it is the first time this has ever happened to the US, which is in what looks like a long-term structural decline. But that is very much a long-term trend which could take years – possibly decades – to play out.

The Government is raising £40m as part of a trial of social impact bonds, where charities, businesses and philanthropists will invest money that will be targeted at families adversely affected by poor education, addiction and crime. In return, the Government says a share of any future cost savings to social services, the police etc, will be paid back to investors. The terms of the investment are still unclear but should private investors be getting involved in the function of Government?

McDermott: No. This sounds like another good idea that is extremely impractical. It is very difficult to persuade people while the Government is increasing taxes and regulation to ask investors to protect the Government in the short term.

I am sure the Government will argue it will do good in the long term but I think this is a bit of a nonsense.

If you were to say that if someone put money in now to tackle social deprivation and it would save money in the long term, I would say that sounds fairly sensible but that is the job of the Government.

Lowcock: I can see the financial implications of doing it at an institutional level so that institutions can value and mark the investments a bit more clearly. The trouble is that any future cost savings would be vague. From an investor point of view, you have to say, “What is the return on my investment?” It is nice to have a social conscience but that does not always work when it is married up with investing.

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