Phuket Post :: Article :: MONEY MATTERS

FTSE100 - 1st JANUARY 2007 6220
FTSE100 - 1st JULY 2007 6640 +6.7%
FTSE100 - 29th JULY 2007 6212 -6.5%

THE ABOVE demonstrates very clearly what has happened in the last few days of July - the year�s gains have vanished in the correction, long predicted, but which finally happened after enough investors finally decided that it would not happen.

Actually the central bankers are likely to be heaving a sigh of relief, because the most dangerous de-stabilizer of financial markets, and hence the stability of the underlying economies often comes from stock market bubbles spiralling out of hand. So, when they do burst, they then cause widespread financial dislocation. This then feeds back into the real economies and undermines them.

This happened in 2000 with the explosion of the great TECH bubble - a bubble that had gone far too far so that when it, inevitably, burst, it left a trail of debris in the real economy leading to a recession.

The two bubbles building up recently, which surely were beginning to threaten the soundness of the wider economic system, were the Private Equity Bubble and the Property Bubble. The steady tightening of credit, which the central bankers have orchestrated over the last two years, has had its effect, and seems to have nipped in the bud these two emerging economic de-stabilizers. Both in fact, were a direct consequence of the great stock market collapse of 2000 (tech) and 2003 (general). Sickened with their losses in equities, large institutional and retail funds rushed elsewhere.

�Alternative investments� was the Gadarene cry, as the unhappy swine looked for a new cliff to plunge over. They swamped the private equity market with huge excesses of capital, and likewise property investment - in the latter case driving yields of commercial property to the lowest ever seen, whilst actually underlying rents were changing little.

Big property investors like Standard Life and Scottish Widows had to close their property funds because they were swamped with more money than they could find sensible investments to put it in.

So these unwanted surpluses swilled off into the AIM, where less scrupulous operators happily dreamed up vehicles, many somewhat dubious, to mop it up. Bulgarian, Ottoman, Rumanian, you name it, property funds sprouted like mushrooms in the night, and like mushrooms may have a rather short life. Altogether ฃ7 billion was raised on AIM for these wonderful ventures, most of whose shares are now lingering at a discount to the issue price.

Then the housing boom almost worldwide was leading to houses being used as cash machines fuelling unsustainable consumer demand and inflation.

The worst aspect of the private equity bubble was that it shifted the profit of the big private equity houses away from the deals they did using their own capital (as in the past, where understandably they were doubly choosy about what they bought and the price they paid) to deals where the lion�s share of the profit simply came from the fees investing the huge sums of other peoples` money thrust upon them. Hence the willingness to take businesses - and very large ones like Alliance Boots - private at hefty prices just to place the piles of cash and get their fees. Their own capital was hardly involved.

Meanwhile the banks were getting stupendous fees for arranging the debt finance, and dared not get off this bandwagon as then their profits would look anaemic compared to their peers, even though they knew that the low quality, poorly secured, loans they were financing and hopefully passing onto each other, might eventually go sour, but not for a year or three, whereas the fat fees went to the bottom line immediately. This toxic loan build up was drawn attention to by Anthony Bolton a few months ago.

When rising U.S. interest rates finally punctured the dodgy sub prime market, and the U.S. mortgage lenders, far from keeping it to themselves, had parcelled it out all over the world�s banking system - a lot of banks nowhere near America got hurt. Then some banks finally decided they did not want any further dodgy paper on their books, so the big corporate bankers to the private equity industry bonanza suddenly found themselves without a chair to sit on, and the music had stopped.

Getting rid of this $20 billion or so of these weak loans is now going to cost these banks probably all the juicy fees they have earned in the last 12 months, and the rest. But it is not worse than that, and whilst one weeps for the evaporated bonuses of these poor bankers, I think it has been stopped long before the whole system got polluted with bad debt.

That is in fact very good news. The bubble has been burst before contagion has spread too widely in the economic system. The same can also be said for the property sector. The bubble is over in the U.S.A. - no more false boosting of consumer spending via re-mortgaging the rising house values (now falling). Spain was hit next, and the U.K. stock market has taking the view since last January that the game was soon to be up in the U.K. also.

House builder stocks have fallen nearly 40% or more. Bovis - one of the best, is down for ฃ12.20 to ฃ7.40. Likewise commercial property shares have been falling all year, down again about 30/40% against a stock market which was up 6% and now neutral on the year. The market had sensed the problems coming, however, with the news as well now turning negative, current depressed levels actually may be discounting a worse outcome profit wise in 2008 than actually turns out. There remains very determined - or it was - but people change quickly when markets fall - longer term institutional investment from all over the world for quality U.K. commercial property. This should not dry up, but will expect to buy in at a lower price. It�s a Dutch auction but at around 5.5% yield on quality property, there appears currently to be plenty of demand.

So again a bubble has been burst but well before it had got dangerously out of hand - as it did in Tokyo in 1989 where the Emperor�s palace and gardens had a notional property value similar to the State of California . - so the following decade in Japan of falling property prices fundamentally weakened the entire Japanese banking system with knock-on consequences for the whole economy.

The likelihood now is that the feared further rises in U.K. interest rates may not need to happen. The foreign exchange market seems to think so, have driven Sterling down three cents in the last four days.

Meanwhile the corporate sector is both flush with cash and generating it strongly, in mining, oils, commodities generally, shipping, pharmaceuticals, aerospace, defence, infrastructure, and the world economy continues to grow quite robustly absorbing the U.S. slowdown.

Bull markets climb up �walls of fear� with periodic sharp setbacks.

Neil Woodford, probably one of the best fund managers alive today, said: �I have been quite busy over the past few days buying shares that have been unnecessarily hit�.

The discussion over possible longer term inflationary pressures and bond yields will resume next month, when hopefully markets will be more calm.

By Robert Skepper

Robert Skepper's London-based investment service can be accessed through Heath Norris, CEO of Offshore Holdings Advisory Tel: 089 871 1782 Email: heathnorris@investrightnow.com