Friday, October 16, 2009

Stock Market Crash? Your Options Explained (Part 1)

We live in interesting times...

You cannot switch on the TV or read a newspaper without hearing of doom and gloom. If it's not property and stock market crash and falls, it's oil prices going through the $100 level, and the situation in Iraq seems to be deteriorating.

Well, we will stay clear of most of that, except the issue of markets across the world going down. At this point we feel like saying please take a deep breath everybody.

It's certainly true that the 'sub prime' crisis has badly affected the confidence in the markets. Just as has the Northern Rock fiasco in the UK and the Bear Stearns collapse in the US. Are there any more 'nasties' around the corner people will rightly ask?

The answer is yes there could be, and things may take several more months for any residual problems to make an unwelcome appearance.

So what has happened?

Well, in a nutshell, it's partly down to greed.

In the last few years many banks have devised complex products to sell on at a profit, with the full ramifications of what they were selling not known at the time.

They packaged various types of debt together - good, average and poor quality - and sold it on. The banks priced these packages with a formulae devised by themselves.

With the benefit of hindsight, it could be argued that they got it wrong in spectacular style.

Roughly speaking, the high risk debt became worthless, the medium grade debt halved in value, and even the high quality reduced in value by circa 30%. This was made worse of course because in forced sales you tend to get less.

There is also the issue of how banks lend to each other, called the Interbank rate, so that they have the money to lend to people like us.

Gone are the days (but coming back?) when the bank used purely savers' money to then lend. So when confidence is hit, and banks are reluctant to lend to each other, and any lending they do do they charge a lot more for.

What we need of course is a period of stability, with bad debt being written off, and Interbank rates settling down. Working capital needs to be found, with wealthy companies called Sovereign funds helping - at a price.

As a background to all this, it must be said that the last 15 years have been quite amazing with low interest rates and high growth. This 'Goldilocks' period is ending, with growth down and inflation up. This brings to mind the dreaded word stagflation, and this is perhaps worse than recession.

Another point is that compared to other periods of stock market volatility the fall in the markets has not looked huge. Compared to the end of 2007 the FTSE is down around 14% and of course may fall further or recover. But in 1974 the market fell 51%, before bouncing back in 1975!

By : Ray Prince
Ray Prince is an Independent Financial Planner with Rutherford Wilkinson plc, and helps UK Resident Doctors and Dentists get the best deals on mortgages, protection and investments, as well as helping them achieve their financial objectives. Just visit to get your free retirement planning guide. Rutherford Wilkinson plc is authorised and regulated by the Financial Services Authority.

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