'Best may already be over for shares'

MONEY TALK
By Jonathan Compton
Director of Bedlam Asset Management

With the FTSE 100 shares index struggling to breach the 4,500 barrier, a leading market watcher explains why the best may already be over for investors.

This summer has seen "unexpected" weakness in UK and world stock markets, the pundits will have you believe.

Be happy, this is temporary, they will tell you.

Markets are bound to recover strongly, oil prices fall, the US presidential election will go well and corporate profits both in the UK and the US are at record highs.

All these comments will be made by financial pundits over coming months - and ever more desperately.

Bootstraps

The illusion of wealth created by the debt boom has masked the fact that the average UK household has seen taxes rapidly increase

It is their job to talk up shares, but the evidence that all is not rosy and that stock markets may be about to resume their fall in 2005 is plain to see.

In 2003, global stock markets roared away after three terrible years.

Record low interest rates, high levels of employment, booming consumer expenditure, property prices and the Chinese economy all helped pull world stock markets up by their bootstraps.

But now all these factors have disappeared or reversed.

Debt bubble

Britons owe more than a trillion pounds through their mortgages and credit cards.

Consumer debt has been rising by an unsustainable 8% a year.

We have had five increases in interest rates since November. As a result, debtors must cut their expenditure.

In short, the debt bubble in the UK and US is coming to an end.

The bubble has been just as bad as that of the dotcom era.

The illusion of wealth created by the debt boom has masked the fact that the average UK household has seen taxes rapidly increase.

One thing is for sure: the heyday of cheap oil which helped boost world economies in the late 1990s is past

In addition, escalating fuel prices, insurance and road tax have all hit family incomes hard.

Creaking

Governments must carry the can for the oil-supply problems currently dogging the world economy, and in turn creating uncertainty in stock markets.

Not a single new US refinery has been built for 25 years; they are at full capacity, old and creaking.

There are many other risks in the oil supply chain.

Despite headlines screaming that oil prices are at a record high, when inflation is factored in, a barrel of crude is still only priced at half the level of 30 years ago.

If the US government releases some of its strategic oil reserve then this may bring some temporary respite.

But one thing is for sure. The heyday of cheap oil which helped boost world economies in the late 1990s is past.

Unfortunately for investors, corporate profits do not yet reflect the significant impact of higher energy prices.

Summer is usually quiet but it has never been like this before Read how savers are shunning shares

Risks

In addition, the Chinese economic boom, so long the welcome surprise package of recent times, could now turn into a hindrance for western economies.

The Chinese economy is sucking in commodities at an explosive rate, and this is forcing up the cost of raw materials - which in turn will eat into corporate profits and increase inflationary pressure.

One extra dimension to this gloom-laden scenario is the possible impact on stock markets of derivative trading.

Put simply a derivative is a financial instrument, traded on or off an exchange, the price of which is directly dependent upon the value of one or more underlying securities such as a company share.

They are often used to hedge risk and are the stock in trade of hedge funds.

In the late 1990s as the dotcom boom ran out of steam some hedge funds trading in derivatives ran into serious trouble.

Nevertheless, over the past few years the hedge-fund industry has grown apace.

But the financial position of hedge funds is notoriously difficult to ascertain.

As a result, if we were to see a sharp downturn in the stock market, we could see some hedge funds struggle - and this in turn could dent investor confidence.

The views expressed are solely those of Mr Compton and are for general information only, do not constitute financial advice as defined by the Financial Services Act and are not intended to be relied on for the purposes of making an investment decision.

Always obtain independent advice from a qualified, registered financial advisor before making any investment decisions.