Three prerequisites of any recovery in the markets are not all met yet

Published on Friday 21 November 2008 18:07

YOU know stock markets are turbulent when daily share price falls receive top billing on the nightly news bulletins, writes Andrew Milligan.

Recent moves have indeed been spectacular. One measure of volatility of the US stock market recently reached double the highest level experienced during the collapse of the internet bubble.

For the advisers competing to become IFA of the Year, undoubtedly such volatility has kept them busy with a surge of calls from anxious clients. More reassurance will be needed into 2009. The reality is there are difficult times ahead, as Europe and Japan are already in recession while the UK and the US are rapidly heading that way. Nevertheless, financial markets are forward looking. So what will trigger the eventual turnaround in market sentiment? Firstly, valuations need to reach compelling levels. We are seeing evidence of this in such areas as corporate bonds, inflation-protected bonds or parts of the stock market.

Cheap valuations in themselves are not enough to spark a rally though – also needed are a strong policy response and an end to forced selling. The first of these receives a small tick. We have seen aggressive action on cutting interest rates, pumping liquidity into financial markets and propping up the banking sector. The recent G20 summit opened the door to a series of tax cuts and spending programmes. Nevertheless, there is much more still to do, for example in dealing with toxic debts or stabilising the housing markets.

Forced selling remains a big negative, for example by hedge funds and other distressed financial institutions facing redemptions from clients or stretched balance sheets. Once this comes to an end, investors will see signs of an underlying improvement in cash flow, earnings, defaults and rental yields to justify a sustained uptrend in risky financial assets. Patience is a virtue in bear markets.

• Andrew Milligan is head of global strategy at Standard Life Investments.