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Troubled times bring challenges

The current liquidity crisis looks set to be worse than the fallout from the crash of technology stocks and it could be at least two years before the market recovers, according to a Morgan Stanley/Oliver Wyman report into the state of banking and financials stocks.

With continued fallout from US sub-prime concerns, UK banks pulling out of the mortgage market, global equity markets falling and the UK fund industry already commentating about the impact it has had on Isa sales, it is little wonder the public is worried. And then there is the seemingly endless run of bad announcements in this area – from the First Direct move last week to the amount groups such as UBS are having to write down in terms of bad debts.

Commentary about the state of financials has become so commonplace that it is hard to even turn on the television without seeing another item trying to explain the situation.

Explaining how we got here is one thing. How long it will last is something else entirely, and regardless of how we got here, it does not look like the situation is going to be rectified any time soon.

Already we have seen a flight to quality from investors – although banks were once considered quality. The Morgan Stanley report says the financials industry is facing a severe crisis. “The global securities markets are in the midst of profound cyclical and structural change,” the joint report reads. The only time revenues have fallen for two consecutive years was in 2001/02 but it is likely to happen again for 2007/08.

“Investment banking and capital market competitors look set to experience the worst hit to earnings in 20 years. This already starts to rival the 1989/90 downturn, which was the most severe of the five crises in the past 20 years. It also looks more severe than the dotcom or 94/95 Mexican crisis.”

Morgan Stanley and Oliver Wyman mapped out each of the past five major market crisis from Black Monday in 1987, Junk Bond in 89/90, Mexico 94/95, Asia/LTCM and Russia in 97/99 and the dotcom/Enron of 2000/01.

In each case it examined the duration, depth and total severity in terms of earnings lost over a number of quarters in order to better picture where we are at today. For example, the analysts note that in the case of Black Monday it took one quarter for earnings to return to pre-crisis levels but total industry earnings in the worst quarter (as a percentage of precrisis earnings) was a fall of some 500 per cent.

The junk bond crisis lasted about six quarters and total industry earnings in the worst quarter fell by 400 per cent, while the more recent tech crash took some seven quarters before earnings returned to pre-crisis levels but depth was less with a drop of some 50 per cent.

Placing the issues of today on this same scale and so far the subprime/liquidity crisis has already exceeded three quarters and it is estimated by the report it is likely to last for at least eight to 10 quarters. So far its fall in the worst quarter has been about 300 per cent.

The report states: “While we are naturally worried by the recent market developments and think that this crisis will run longer than many previous events, given global growth and the intense policy response, we are hopeful that a return to prior earnings levels is still possible in the next six to eight quarters from now.”

Andrew Milligan, head of global strategy for Standard Life Investments, says: “In recent weeks, policymakers in most of the major economies have admitted that not only will the US be in recession in 2008 but that global activity will be subdued well into 2009.” Investors, he says, are beginning to realise that the outlook for most of the major economies is a prolonged period of sub-trend growth.

Choosing where and when to invest as well as reassuring clients becomes the challenge for advisers in such a market environment, particularly when market and fund performance has not been too helpful in those regards. As is typical whenever there is a large-scale sell down of markets, most fund managers are currently citing the oft quoted ‘buying opportunities’ mantra. That is not to say this is not true and that should be kept in mind, particularly for all those holding cash waiting for the market to turn around.

The impact on financials has been one thing but this crisis has, of course, also impacted on the broader market, drawing down western markets and more recently hitting some of the previous darling areas such as India. In the three months to April 2, only 184 onshore funds out 2,221 achieved positive returns.

In a reversal of fortunes, sitting at the bottom of the table are predominantly India and China portfolios, Asian funds as well as technology vehicles, according to Trustnet data.

Of the funds which made advancements during this difficult opening quarter, sitting at the top of the charts are a high proportion of gilt, cash and government bond portfolios, although mixed in among these are some total return portfolios and even property funds.

Financials funds, even though they are just a few, have fared somewhat better than one would expect considering the bad news in the market – they are by no means the worst performing area of the market despite the fact the crisis has emanated from that sector.

Within this same table of performance, Jupiter’s Financial Opportunities portfolio shows a fall of 9.9 per cent, as opposed to the 20 per cent plus drops seen among the Asian funds and it places the specialist fund at a ranking of 1,973 out of 2,221. New Star Global Financials is not far off of this with a fall of 14.2 per cent, ranking it 2,199.


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