Being out of the commentary business for most of 2008 has been a mixed blessing reflects Jonathan Davis.

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On the one hand there have been so many extraordinary things to talk about. On the other, the difficulty of making coherent or helpful comments in a world where the crisis unfolding by the day makes prediction even 24 hours a head virtually impossible. The last month has certainly been the most remarkable I have experienced in 30 years of writing about financial markets.

The biggest single insight that has guided my thinking over the past nine months has been a private conversation with a central bank director towards the end of last year which persuaded me of several unpalatable truths:

• The banking crisis was going to be deeper and more severe than most people at that stage were imagining it could be;
• Enforced deleveraging would eventually have an impact on almost every type of investor and asset class, although the precise sequence of events was impossible to predict.
• The people most worried were the bankers themselves (which is why the banking system has effectively been gummed up ever since);
• Central bankers and policymakers in government had no idea exactly how bad things could get (except that it could be very bad);
• Nor did they have great confidence in how to deal with – let alone prevent – the crisis unfolding.

All of which has led me to the inexorable conclusion that this was no time to be taking unnecessary risk. Listening to my gut rather than my head, as I noted earlier, is what led me to move further into cash and take money out of emerging markets and other riskier assets over the course of the first few months of this year.

Since then it has been a case of sitting largely on the sideline and watching the market action closely for evidence that the bottom of this crisis might finally have been reached. Until last week, that evidence was not on the whole forthcoming. In the last few days, however, even before the big rally today (Monday October 13th), there have been increasing signs that we might at last be through the worst, at least for now, and possibly for some time.

Those who I listen to regularly have certainly been preparing the ground for a stock market recovery, however bad the deteriorating economic fundamentals might seem. Anthony Bolton is just one who has recently been nailing his colours to the view that the current phase of the bear market is almost certainly over for stock market investors. His argument has been that shares in certain sectors, such as retail and media, are as cheap as he can remember at any time in his 30-year career.

But he is not alone. Neil. Woodford, whom many regard as the natural successor to Bolton as the UK market’s strongest fund manager, has also been making more positive noises. Those who want to hear his views can look at this transcript of an interview for his fund investors a few days ago. I have also attached a note from Tim Bond, Head of Asset Allocation at Barclays Capital, arguing that equities are now the cheapest they have been in a generation, and a comment from Lombard Street Research making similar positive noises.

Given that stock markets are discounting machines, the level to which most major markets have fallen suggests that the issue now is really about how far and how deep the enforced economic slowdown across the globe is likely to be. If we are looking at 12-15 months, the time to start loading up on equities again is probably around now. If the outcome is going to be something longer and deeper than even conventional wisdom is forecasting, there may be another downleg to go, in which case we could be talking about the middle of 2009 before the market recovers in earnest. 

What is undeniable is that genuine fear, the precondition for a new bull market, has been stalking the investment landscape. Only those from Planet Zog can be unaware that the world’s banking system is in crisis. It has become the first topic of conversation in every home and office. That implies that most of what is going to happen is now in the price.

To be sure there will also be continued volatility and the headlines are going to remain grim as the economic downturn starts to take effect. The risk of further mishaps in the banking system clearly remains. But for the first time in months there are grounds to hope that the end of this remarkable crisis is now in sight. Investors don’t want to be cutting their equity exposure any further and those with cash should be ready to take remedial action.

As to the longer term consequences, I share the view of Warren Buffett that our priority now is to fix the problem, and leave till later the issue of fixing the system that created it. Whatever moves towards tighter regulation eventually emerge, I cannot help recalling a favourite saying of Ronald Reagan, to the effect that the most frightening words any of us can hear are “Hello. I am from the Government and I am here to help”. We are about to see that proposition put to the test in a way – and on a scale – that can barely be imagined.

 



Jonathan Davis
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