The Great Dislocation: Investec

Philip Saunders, Head of Investec Asset Management's Multi-Asset team writes that in recent weeks we have witnessed an unprecedented general market dislocation. Although the impact on real economies is undeniably going to be greater than was likely to have been the case before the events of the last three months, forced selling has resulted in the prices of many 'risk assets', including equities, falling to levels that now discount the severest of economic outcomes.

In short, prices have been set against a background of a financial panic and not as the result of a rational assessment of future outcomes.

Even conservative valuation measures suggest that there is a sufficient 'margin of safety' for longer term investors to buy (or hold) now, even if the ultimate low point in markets has not been reached. Indeed, given the determination now shown by governments across the world to do 'whatever it takes' to ensure the proper functioning of credit markets and to mitigate the impact of economic weakness, in the immediate future the risk of a sharp rebound in equity markets may be actually greater than further sustained declines.

As the Japanese experience of the 1990s showed, the stabilisation of the banking system still could not prevent the severe deleveraging that had to occur in the real economy. However, it did moderate its impact. This is exactly what we have to expect in the developed western economies.

Consequently, negative market news will be bumped off the front pages, replaced by a focus on macro-economic news reflecting themes such as the slump in consumer spending and a sharp rise in unemployment rates. Given the extent of the undershoot in market prices, it is entirely consistent to expect the financial market healing process to continue well in advance of any meaningful improvement in economic prospects.

As the credit crisis has shown, the world economy is more inter-connected than ever before. This has a positive as well as a negative side. Medium-term market prospects will depend on the depth and duration of global economic weakness and its impact on corporate earnings.  While the latter are likely to be poor for the time being given the severity of the 'great dislocation', there are some reasons to be hopeful. Declining inflation will allow interest rates to be cut to very low levels, thus providing relief to debtors and consumers will benefit from the bursting of the commodity price bubble which saw oil prices spiral to almost $150 per barrel.

Paradoxically, many emerging economies are in better shape than those in the developed world. Fiscal positions are good, savings rates are high and banks are conservatively positioned. These countries are likely to boost domestic demand and increase spending on infrastructure which will in turn provide a renewed global growth dynamic. Finally, many developed market companies - in stark contrast to what proved to be the case with many  banks - have solid balance sheets and sound business franchises. It is these businesses which we believe represent attractive real assets that will endure and grow over the longer term.

It is entirely natural for people to conclude from the extraordinary events that we have witnessed in recent months that "this time, its different" but I suspect that we should do well to recall Sir John Templeton's observation that these are the "four most dangerous words in investment". They apply equally to "bear" markets as to "bull" markets.