A different prospective

As we trawl through the heaps of reports winging their way into our in-boxes, in an effort to make some sense of the last few days, I append below some of the more interesting comments for those clients who can summon the courage to refelct on events.

Defaqto say "Speculators, who for so long pushed up the price of oil, pushed it down.

In all the hullabaloo of recent months, two laws have been forgotten. Rule 1: In the long-term, price is determined by demand and supply. Rule 2: Demand falls with price. (Or as an economist would say, the demand curve slopes downwards from left to right.)

In the short-term, demand, for oil and, as it also appears, for houses, is quite inelastic – meaning that demand is not affected by price. But in the long-term this is not the case. As price goes up, demand stays put, the economy suffers. Then demand falls, and price begins to fall too. The economy recovers.

Some said that the bail out of Fannie Mae and Freddie Mac marked the turning point of the credit crunch. Events of the last few days have surely shown how wrong this view was.

Some said the failure of Lehman Brothers heralded the turning point. Yesterday’s fall in shares surely shows how wrong that piece of analysis was.

But yesterday’s fall in oil is a different matter altogether – and provides the single biggest reason to expect recovery."

Edward Bonham Carter of Jupiter comments: -

"These events are likely to shake confidence in the financial system and lead to a fall in inflation. One would expect economic confidence to take another knock as a result, and the probability of interest rate cuts to increase. Without rate cuts, the coming economic recession will be significantly exacerbated.

History will judge whether the Fed's decision not to save Lehman proves to be the correct one. Such inaction suggests that for the effective operation of shareholder capitalism, firms must be allowed to fail.

The authorities are placing belief in the proposition that an investment bank such as Lehman can go out of business without triggering widespread panic in the rest of the system. At the same time, it remains the key role of authorities in the US, Europe and the UK to ensure that while shareholders are exposed, individual depositors and the banking system are protected. Confidence in these must be maintained above all else.

As yet, it is too early to establish what the full consequences of these events will be. However, the stock market is likely to remain volatile and investor confidence fragile as the true impact of these events and the wider effect on economic growth is assessed.

However, while the investment environment remains volatile, investors should recognise that it is in these sort of conditions that significant investment opportunities can emerge. As such, they can present a buying opportunity for those prepared to take a long term view. It is also in such volatile conditions that the practice of drip-feeding investments into the stock market through regular savings schemes can prove beneficial."

After studying column after column it is clear that going forward the outlook remains extremely difficult to call. Over the next twenty four hours we may have further significant events from policy makers with aggressive US interest rate cuts now being priced in by markets, starting from tomorrow’s FOMC meeting. The market has moved to a near certainty that rates will be cut. If this is the case, it is likely that the Bank of England and the ECB will follow, in part to avoid currency overvaluation and even bigger internal economic problems.

Liquidity is being pumped into the financial system but, like similar previous occasions this and last year, it’s not enough – risk and borrowing aversion remains at high levels. In the short term, it is likely that risk assets will continue to suffer while safe haven bonds will benefit.

In summary we believe that the short term will be tough for equities and credits and there is a good chance of further downside in prices in coming days. Lehman Brothers has proven that the bar for those ‘too big to fail’ has just been raised.

For the majority of our clients we are still recommending "sit tight" as long as investment are diversified across asset class and sectors. We appreciate the concerns everyone is facing just now.

Bouncy, Bouncy Oil

Oil was down again yesterday, falling to just $102. That was the lowest price since April and $43 dollars down on the year high.

For several months now, it has been predicted here that oil was near peak, and would soon begin a steady decline. But when the fall did occur a few weeks later, we were taken a tad by surprise. It had come so quickly. But then if the credit crunch of 2008 has one overriding characteristic it is that it has all happened quickly. House prices are falling faster than the most bearish commentators would have believed, so why shouldn’t oil fall as fast too?

There is plenty of evidence, discussed here on innumerable occasions, to show how demand for oil in the US, UK and Eurozone is falling. But then this morning, OPEC reduced oil supply. “All the foregoing indicates a shift in market sentiment causing downside risks to the global oil market outlook,” said an OPEC statement.

“Actions will be taken by members as soon as they can, that means in the next 40 days,” said the Algerian Oil Minister Chakib Khelil, who chaired the OPEC meeting. The parallels with the housing market are clear. The housing market has been characterized by both suppliers and customers running a mile, and we end up with a kind of race to the bottom, with price determined by which falls the most, demand or supply. At the moment, of course, there is a limit to how much demand for oil can fall. This black liquid has, after all, been the lifeblood of the global economy for the last one hundred years or so. Even so, it seems unlikely OPEC will cut supply sufficiently to stop further falls in oil in the longer term.

Yesterday, the black stuff fell by over $4; within a few hours of the OPEC announcement it was up a couple of dollars. But, markets do tend to overreact, so the trend for oil is still likely to be down. OPEC would, in any case, be making a huge mistake if they cut supply so much that the price went shooting up again. There are alternatives to oil out there, it will just take a lot of money to develop them. But once this money has been spent, and more and more of us use these alternatives, the cost will fall. New technology works like that. Once the initial development cost is funded, price falls rapidly.

OPEC’s best interests are not served by trying to prop up the price of oil. Take into account the threat of global warming, however, and it could be argued that the world’s best interests are served by expensive oil forcing the development of renewable alternatives.

Now is not the time !

Now is not the time to ignore your life assurance and protection arrangements. In fact during these difficult times it is probably more important than ever that you can relax in the knowledge that your business and/or personal life can continue should the worst happen to you, your partner or your business partners whether by way of early death, illness or accident.

The credit crunch has had a huge impact on the lending market. Homeowners are trying to borrow more money against their homes, business against their business’s and lenders are increasing the cost of borrowing, as a result of falling property prices, finances are becoming a strain for many. For some, life insruance is offering a short term solution to their financial woes. Homeowners with young families are cancelling Life Insurance policies and hoping the worst doesn’t happen, businesses are also running unwarranted risks. This could not be a worse idea. Often a new policy will cost more because the older you are the more expensive life insurance becomes, you may also lose out on some benefits and features included in your current policy.

It is far better to use alternative means to reduce outgoing and think about sacrificing things that might be putting more of a strain on your finances thank you might think. For instance, smokers who quit buying a 20-pack of cigarettes a day this time a year ago would now be £3,108 better off. Due to the increased health risks from smoking, most life assurance companies charge smokers over 50% more than they charge non-smokers. Smokers who’ve quit should ask their life assurance company to re-evaluate their original policy and charge them the cheaper ‘non-smoker’ rate once they pass the qualifying period.

Cashing in life insurance is not advisable in such situations of stress like the credit crunch. Life insurance is vital. The first step to getting life insurance is to find out what you might already be covered for. If you have an endowment mortgage, for example, this will include an element of life insurance to cover repayment of the loan on your death. It will only cover the amount originally borrowed, so if you've extended the mortgage over the years then this extra borrowing won't be paid off by the policy. So work out how much money will be needed to pay off all debts, including the mortgage, credit cards, business loans and personal loans.

Also the life insurance market is one that you can rely on during the credit crunch. Fierce competition in the life insurance market has kept premuims at reasonable levels at a time when all other household bills seem to be going up. For example, a 32-year-old male non-smoker could buy £100,000 of cover over 25 years for less than £8 per month. Even £500,000 of cover over the same period would cost less than £30 per month at current prices.

Unfortunately, in an effort to save cash, homeowners and business owners are ditching life cover. Just 20% of new borrowers are opting for life cover to protect their loans. This is not advisable and just because everyone is trying desperately to save money, this is no reason. They are underestimating the importance of life insurance and see is as non-essential.

While it might be hard to make ends meet in the current financial climate, it will be a great deal harder for one person to manage the mortgage repayments on their own should their partner die in the future.

The same argument applies for business partners. With so much pressure on keeping the business ticking over imagine the additional burden were a senior or key member of staff to suffer a critical illness or die prematurely. Apart from the tragic consequences for the immediate family, what would happen to your business? Profits, clients, business loans, responsibilities to staff, plans for the future – would all be affected in one manner or another. Business protection gives you peace of mind knowing that if anything happens to your people, plans are in place to protect.

Time to fix that rate?

With the base rate on hold for another month and some major lenders reducing their fixed rates, is now the time to switch to a fixed rate mortgage?

Probably not, say the experts who predict that fixed rates may fall further in the next few months and suggest that trackers are a better punt at the moment. Amongst the lenders that have already cut their rates Nationwide has dropped rates on all its mainstream fixed-rate mortgages and some of its tracker deals for new customers by up to 0.46 percentage points and Newcastle building society has lowered its two-year fix for borrowers with a 25% deposit from 6.20% to 6.12%.

Halifax also announced cuts of up to 0.15 percentage points to its fixed deals last week. Its five-year fix for customers with a 25% deposit has gone from 6.49% to 6.34%. BM Solutions, Bank of Scotland and Intelligent Finance, which are part of the same group as Halifax, have also made cuts as have both Cheltenham & Gloucester and Abbey.

Swap rates, the starting point that lenders use to determine the price of their fixed rates, have fallen dramatically over the last few weeks, coming down 0.7% from their peak a month ago. Even the bad news on inflation has failed to dent their progress downwards, and now lenders are, theoretically at least, able to offer better priced products. Although this sounds like good news there are still a couple of factors that might prevent fixed rates dropping straight away. Firstly, lenders have been looking to increase margin rather than market share, so have priced more profit into their products. Secondly lenders are concerned about being inundated with applications so they don't want to appear too competitive.

However with swap rates likely to decrease further with expectations that bank rate would be cut before the end of the year there may be more cuts in the next few months so borrowers that can hold out before locking into a new fixed rate might be wise to wait before they do so. Those lenders that haven't reduced their fixed rates yet also have some catching up to do. At the moment trackers and variable rates appear to be the best bet for borrowers looking for a new deal although these will be still be more expensive than most deals coming to an end.

Borrowers coming off fixed deals taken out two or three years ago will have to cope with a significant "payment shock" and find extra money each month whether they revert to their lender's standard variable rate (SVR) or remortgage. For example, someone who took out a £100,000 two-year fixed rate with Nationwide two years ago at 4.65% could see their payments increase from £570.70 a month to £682.55 when they revert to the base rate of 6.49% assuming they have taken out a repayment mortgage over 25 years. Nationwide has recently reduced the price on its tracker mortgages with the most significant movement on its lifetime tracker, coming down an impressive 0.36% to bank rate +0.98% for those with a 25% deposit - albeit with the introduction of a modest £599 arrangement fee. Meanwhile Woolwich has decreased the rates on its lifetime tracker product. The best rate available is now 0.69 per cent above base rate with a £995 fee and early repayment charges for the first three years.

However only borrowers with a decent deposit or plenty of equity in their property will be eligible for the deal as it comes with a maximum loan-to-value (LTV) of 60% although according to Council of Mortgage Lenders data this accounts for 50% of the mortgage market. Homeowners with a smaller deposit or less equity will be charged more, both by Woolwich and rival lenders.

Tightened criteria, such as insisting on a large deposit or large amount of equity, is a side effect of the credit crunch as lenders are becoming more fussy about who they lend to. Those with a slightly dodgy credit history or borderline affordability will also find it more difficult to get a good deal.