It will be some days or even weeks before it can be determined whether the latest rate cut can steady US markets, stave off a recession and provide the economic stimulus for growth in company profits and share prices. Investors, who have seen sharp falls in share prices in recent weeks, should brace themselves for a bumpy ride in coming months. Many market analysts believe there will be further bad economic news and corporate profit warnings out of the US over the next three to six months. This will ensure that equity markets remain volatile with false recovery dawns followed by sharp falls.
Against this background the Federal Reserve is expected to cut interest rates aggressively. Some economists expect further cuts of between one and two percentage points over the next six months to ensure US economic recovery. That should be good for share prices. But a significant effect on markets is not expected for some months.
To put the current market volatility in context: On Monday the Nasdaq closed at 1,951.18, well under half its high of 5,078.86 reached on March 10th 2000. But even at Monday's closing level the index was still ahead of its level at the beginning of 1998.
The Nasdaq began 1998 at 1,570. By the end of the first quarter of 1999 when the technology bubble was taking form the index had reached 2,493, a gain of 59 per cent. That TMT bubble continued to inflate through the second half of 1999 until it reached 5,078 on March 10th 2000.
From the beginning of 1998 to March 10th 2000 the Nasdaq rose 220 per cent. Between March 10th 2000 and March 19th 2001 (index: 1951.18) the index fell 62 per cent. On Monday its was 24 per cent ahead of its January 1998 level.
Last Monday the Dow Jones closed at 9959.11, a fall of 8 per cent on the week. However, even with this fall, the index is still some 26 per cent ahead of its January 1998 level.
What should investors do now? At the moment cash is king and investors may be well advised to hold off investing in equities until the bottom of the market is in sight. But even the experts find it notoriously difficult to call the bottom so careful share choices in coming weeks could provide good rewards.
Fixed-rate products such as bonds are attractive investments at the moment in an easing interest rate cycle - until the end of the rate cuts are in sight. Investors already in the market nursing losses should probably try to take a medium-to-long term view and hold out for an upturn. Once money starts to flow back into equities analysts expect consumer cyclicals such as retailers to the first beneficiaries. Some analysts suggest that consumer technology could benefit next as consumers start to spend. But investors, especially risk sensitive investors, should stick with large strong profitable companies and avoid any dot.coms that cannot produce a robust and achievable business plan. Investors in tracker bonds and with-profit products are likely to see further falls in values. But while investors can expect further falls over the next six months, selling out now will mean certain loss and the funds should recover with the markets. The bottom line is that the markets are going through a difficult period driven by fears about the US economy. Until these fears are dispelled stock markets cannot stage a sustainable recovery. Though equities have shown strong growth in recent years they are generally cyclical and investors should expect volatility. There is money to be made but the risk stakes are high. Nervous investors are better off on the sidelines in current markets.
