It seems that every time the UK economy takes a dip many people start to question whether the stock market really is the place to invest your money in the long term. While the facts and figures speak for themselves, with the stock market out performing any other invest class over the long term, there are times when it might be best to stay out of the market, but in the long term where else would you invest your money?

The stock market is the barometer of the UK economy and whiles some asset classes will do better than others over different time spans, it is the mix of asset classes which offers investors comfort that the long term performance will mirror that of the UK economy. Many people seem to miss the bigger picture with the stock market, assuming that the main aim of the exchange is to allow investors to buy and sell shares, when in fact this is what is known as the secondary market. We hereby list some useful aspects of the stock market which often go unnoticed :-

Treasury Funding

The government use the GILTS market to raise funding to cover the peaks and troughs of government budget requirements. You will see that when the economy is doing well and public spending is under control, the government may actually redeem part of their GILTS portfolio which is held by fund managers and private investors alike. When the economy is under a little pressure as it is now, you will very often see the government selling off GILTS to investors in return for a fixed rate of return and money to fund public services.

GILTS are the most secure of any investment in the UK as they are backed by the government. If the government was ever to renege on repayment of a GILT then we would all be in deep trouble.

Primary Market

While we all see the headlines about new companies listing on the UK stock market, they can raise funds at this stage or it can be used as a way for a large investor to reduce or dispose of their holdings. More often than not the company coming to the market will sell new shares and raise extra capital but this is not always the case.

Secondary Market

The secondary market is probably one of the main attractions of the stock market to investors and companies alike, this is the time when companies will attempt to sell additional shares to investors for what could be a number of reasons, expansion plans, a take over bid or a desperate rescue rights issue to save a company.

A lot will depend upon the reason for the fund raising, how much they are trying to raise and the general state of the market. A company looking to raise funds at this moment in time, no matter how strong the argument, would probably struggle or need to price the new shares lower than a couple of years ago when the market was much stronger.

There is a lot more to the stock market than just buying and selling shares, it is the heart beat of the UK economy and assuming that you give yourself a good spread of investments it is possible to benefit from the long term economic growth which is expected in places such as the UK.

Bank policymakers of UK are concerned about the expected high inflation levels and the consequences the industry will face. It is feared that the inflation will increase over the period. Bank of England is struggling with the rising price pressures and slow growth rates and the soaring inflation expectations will also affect the interest rates as it will come down more slowly than expected. Bank of England in its February survey stated that the public expect the inflation to be around 3.3 percent in the coming year and also the current inflation levels have jumped to a record level of 3.9 percent.

Bank of England setters have also warned that the impending inflation originated by the rising and falling cost of worldwide commodities will worsen the situation further and the actual threat to UK’s economy will be further price hikes and more expectations of the public which may lead to higher inflation levels.

BoE has reserved the rates at 5.25 percent during the first week of this month however shareholders are making a bet that the rates will fall as low as 4.5 percent within this year. This kind of predictions also makes the position of the Monetary Policy Committee more difficult as this dampens the interest rate cut in the near-term. It is believed that the workers may demand higher wages to meet the rising prices of commodities and the industry will be forced to increase the wages to retain them.

Many economists feel that the consumer’s inflation expectations are overly influenced by the increased price of essential commodities such as petrol and bread. According to the economists, because of the latest price hikes and the increased rates of food price the public tend to expect the inflation to grow at a higher rate and the fact that this piece of information is widely exposed further supplements the belief.

The CPI inflation as per the last reading was 2.2 percent in January. The retail price index which also comprises of mortgage payments was 4.1 percent during this period and the news has created much concern for BoE as the high inflation expectations will reduce the chances of quick cut in interest rates. Since December, Bank of England has undertaken two quarter-point cuts and has kept the standard rate at 5.25 percent. So, for the moment the economists feel that the Bank’s apprehension about inflation has balanced its growth fears.

The prime factors that affected the CPI had also affected the RPI and the mortgage interest payments had a downhill effect on the RPI during this month. Also, the RPIX inflation on all the items excluding mortgage interest payments had risen to 3.4 percent in January from the 3.1 percent mark in December. Moreover, the largest growing pressure on RPI is due to the raise in the price of fuels. With oil prices at 110 dollars, the inflation rate may further rise to record prices and economists are also voicing their fears to the Government.

In a move which is sure to have epercussions for world stock markets when they reopen on Monday, the Dow Jones was rocked on Friday, falling over 2% after a raft of downbeat announcements.  It  seems that the combined effect of announcements by Caterpillar and Bank of America have brought home the delayed impact which the recent credit crunch will have on the economy.  As we all know, if the US sneezes, the rest of the world catches a cold, so influential are their markets.

So what does this mean in the short term?

In what some may see as a healthy correction, you can expect a fall in world wide markets in the short term and it seems inevitable that interest rates in the UK and US may have to move lower to lessen the impact on economies. 

What happens if the economy slows?

A slowing economy can have a massive effect on employment, investment and the government budgets for public services.  The more people unemployed will reduce the tax intake, which will mean either additional borrowing by the treasury or less money for public services.  The economy is like a large ship which is very hard to steer, and takes a long time to change direction.

The authorities now have an excuse to reduce interest rates, and while there have been reductions overseas, the Bank of England have held steady and not taken any knee jerk decisions so far - which has been applauded by many, but criticised by others.  The next few months will be vital!

While there have been many doom and gloom merchants on the TV and in the media, forecasting massive falls in stock markets, and a slowing of the worldwide economy, we have yet to see any confirmation, but is it on the way? Or has the financial world rode out the dangers of the credit crunch?

On the surface it seems as though worldwide markets are now over the worst, but is this really the case, or is there a storm brewing for the future? Historically we will not see the worst effects of the recent episode until the announcement of company results, with all eyes on the financial sector.  There is no doubt that holes have been blown open in balance sheets, and there is pressure on profitability, but is it really under control?

The price of gold has been rising steadily over the last few months, and is close to an all time high.  Seen by many as a safe haven in times of trouble, it has often moved in the opposite direction to worldwide stock markets.  Will the gold price fall back, or have markets remained a little too resilient after the recent episode? As we mentioned above, the full impact of recent events will not become apparent until company’s release their half year and full year profits, and more importantly forecasts for the immediate future. 

A prominent economic group have recently forecast that up to 6,500 jobs are at risk in the City of London’s financial district - a hangover from the credit crunch.  In the UK it seems as though the economy is set for a period of great turbulence, which was part of the reason why Gordon Brown even contemplated calling a snap election.  While the skies may be clearing, we are not out of the woods yet!

Recent events in the money markets have shown that once you sign that mortgage / loan deal, do you really know what happens, and where your liability may end up? Unless you have done some major research into the sector, you will probably not be aware about what goes on behind the scenes.  Let us tell you what happens…….

Once you sign that mortgage or loan deal, there is every chance that your agreement could be split up into many pieces and sold to a number of financial companies around the world.  But how is this done?

Simple!

When you sign a financial agreement you will create two separate income streams, interest and capital, which will be stripped and bundled up with a variety of other financial elements.  By bundling many different qualities of income stream into a new financial instrument, it is possible to create a customised vehicle for any requirement.  Risks and the duration of the instrument can be varied simply by taking on different “strips” of any other agreement.

So in effect you take your mortgage out in the UK and within a matter of days your agreement could be scattered to all areas of the world.  This is part of the problem with the ongoing credit crunch in that nobody really knows who is at risk until the pack of cards start to fall, then A cannot pay B who cannot then pay C, and so on.  After a short period of time, liquidity dries up, finical institutions need to retain their funds, and the internal money market is dead.  Step forward Northern Rock for 75% of that last mortgage they agreed, in the form of a commercial loan, but the funding is not there!

While the above description may sound a little simplistic , it really is that simple.  A lack of confidence in the money markets can lead to banks withdrawing their finance from the markets, which results in other companies not being able to function normally, which results in Northern Rock like situations.

Northern rock is a little different than most banks as it borrows a large amount of mortgage funding from the market, rather than being in a position to use its own assets.  The likes of Barclays, Lloyds, etc are total different in that they are more likely to use their own asset to back 75% of a mortgage agreement, and borrow 25% from the money markets. 

The UK credit crunch has now taken hold of its first major UK causality, with Northern Rock forced to call on the Bank of England’s “lender of last resort” system, to bail out their business.  While the situation is only short term, it has caused major upset with the Bank’s customers with over £1 billion of deposits withdrawn over the last couple of days.  So how did Northern Rock get into this mess, and is it terminal?

The problem with the Northern Rock business model is the fact that they lend 75% of all mortgage amounts from the inter bank market - effectively borrowing money from their banking counter-parts.  This has left them more wide open than most to the recent disappearance of commercial lenders, in light of concerns within the US financial markets.  As lenders have disappeared from the market, Northern Rock have been pushed into a corner whereby they have had to call on the Bank of England to allow them to agree future mortgages.  So how much will this cost Northern Rock?

While the loan situation is purely a technical phase, the Bank are being charged an enormous 6.75% by the Bank of England, which will reduce their profit margin on future mortgages.  Last year the group made profits of some £500 million, so you can see from their history that they are not a small bank.  Unfortunately, while the turmoil continues and customers clamour to withdraw their funds from the bank, their reputation is being ruined and when the situation calms down they will almost certainly become part of a larger group, with the  likes of Lloyds TSB being mentioned as a possible suitor.

While many may not have been aware of the internal credit market before the recent downturn, it does demonstrate how events in another part of the world can result in the collapse of confidence, and even businesses, in another area of the world.   The financial markets around the world are so entwined that the knock on effects can last for some time, and have disastrous effects.

Northern Rock may be the first major UK bank to hit trouble, but there are rumours that a whole host of others are finding life tough.  This is not the last of the credit crunch problems in the UK, you can be sure of that!

After the calm, we are set for another storm as the US initiated credit crunch claims its first UK victim, with the fall of Victoria Mortgages, a UK based sub prime mortgage lender.  Despite having a mortgage book of some £500 million the main banks have withdrawn credit lines and the company has been forced to into administration.  Is this the start of a new phase of economic turbulence?

The longer the UK financial sector appeared to have missed the US credit crunch problems, the more easier a number of investor were breathing.  However, a little after a month after the US market hit problems we are seeing the repercussions on the UK market and Victoria Mortgages will not be the last to suffer. While the company was still viable, the major credit providing banks (Barclays Capital and UBS) withdrew their funding because of concerns about the market overall.  So how will the stock market react?

The stock market reaction as yet has been fairly muted, although it is struggling to make any real headway forward.  Many investors are sitting on the sidelines waiting for the next big sell-off, which many analysts are expecting over the next few weeks.  What will cause this next round of sell offs?

The next round of sell offs could be a mixture of small players being forced into administration (a constant drip feed of negative news to the market) or the collapse (or major deterioration in the health) of one of the majors mortgage lenders.  The next few months are going to be very difficult for worldwide stock markets, and there will be many investors afraid to dip their toe into the water just yet. 

There are difficult times ahead, with mortgage rates set to rise due to the increased cost of inter bank borrowing - all at a time when base rates are high, the economy is slowing and the property market looks on the verge of a possible turning point.  Caution will be the watch word for some time to come.

While we have all heard about the sub-prime crisis in the US and the problems in the credit market, many are asking how and why a problem with the US economy should effect other areas of the world such as the UK.  While it is a very valid point, there are a number of reasons why it actually happens.

In brief, while the US economy is the largest and most powerful of the economies around the world, in effect there is only really one economy - the worldwide economy.  Individual areas such as the US, China, UK, etc have an impact on the worldwide economy to varying degrees, but such is the integration of multi-national companies, the ease with which you can purchase goods and invest overseas,  that basically all economies are connected in some way.

A drop off in the Chinese economy would impact upon demand for US goods and US services, which would then impact on the US economy where companies may have to cut costs, thereby impacting on the property market as more people find it difficult to find full time employment.  These are the types of connections which are now common place.

The financial sector is one of the purest forms of a worldwide market, with for example mortgages secured in the US probably sold on throughout the world as parts of more complicated financial instruments.  This has been one of the reasons why the credit crunch in the US has actually overlapped into areas such as the UK, etc, where many UK institutions have taken on exposure to the US mortgage market - with potentially billions of pounds at stake!

As worldwide economies become more and more entwined, the chance of knock on effects becomes even greater - something which we are seeing more and more of.   

While we are currently experiencing a short term lull in the US credit crunch crisis, it has already had a major impact upon the corporate finance industry, the movers and shakers who put the big takeovers and mergers together. While funding has been relatively cheap for some time, the ongoing credit crisis has seen funding costs literally shoot up over night. So what next?

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There are a number of implications for the current situation, the lack of corporate funding being perhaps the main one, but stock prices are set to fall further as well. Over the last 2 years we have seen a number of high profile mergers and acquisitions, something which has impacted upon the share price of many companies. For every takeover or acquisiton which has actually happened, there have literally been another 100 rumoured ones yet to materialise. So how does this effect stock prices?

Much of the recent boom in stock markets, especially in the US, has been on the back of takeover speculation which has pushed some share prices to crazy prices - prices which can easily fall sharply if no takeover occurs. As funding for such takeovers has become more expensive, and it will be difficult to raise large sums of money in the short term, we will see much of the “froth” taken off many share prices.

Even when stock markets around the world have calmed down, the froth from the ramped up prices will continue to fade away. The effects are then two fold, in that stock markets will slowly fall back to more realistic levels and investor sentiment may turn negative as they slowly see their investments falling back down to earth.

All in all we are likely to see a lot less corporate activity over the coming months, and this current credit crunch is by no means over - the US Federal Bank would not take such drastic action as seen last week, without knowing there is further bad news to come.

Worldwide stock markets have today received a welcome, although unexpected boost with news that the US Federal Reserve have reduced US base rates by 0.5% to 5.75%.  In a move which was designed to both inject liquidity into the money markets, and give the economy a much need boost, stock markets have rebounded sharply from recent lows.  But is the worst over?

While a move such as that experienced today is not so unusual, in the past it has often precluded more bad news which the Fed were aware of, but which was maybe not yet in the public domain.  Even though the markets have good reason for this show of short term relief, the situation is far from over and there will still be further fallout.

True, there will be more readily available liquidity in the markets which may see many firms over their bad times, but some companies have already suffered beyond reasonable repair.  Many of Wall Street’s larger companies have become embroiled in the situation, and the fact that many are looking to be bailed out by larger banks around the world is a marked change from their front running attitude of the past.

The stock market is a volatile and unpredictable beast at the best of times, and it has a habit of biting back just when you think you have tamed the beast.  Today’s substantial buying pressure has been greatly received, but those who think the situation is now over may soon be disappointed.  The central banks around the world cannot support such man-made situations forever, and there will be some form of accountability at some stage - “pay back time”. 

Once the current euphoria calms, many will still wake up to the fact that the US property market is still in big trouble, personal debt has never been higher, and much of the recent stock market rise was pinned on the back of takover and merger rumours.  It is highly unlikely that we will see an immediate move back to wild takeover speculation, something which may bring many more share price valuations back into line with reality.

It is essential that investor tread cautiously in what is still a difficult period for world markets.