RECENT months have not been much fun or rewarding for equity investors. The three months to the end of September was one of the worst quarters on record.

Equity markets fell as much again in October, even after a hesitant recovery of some of the lost ground towards the end of the month. With most major markets down over 30% this year, 2008 has been one to forget from investors' point of view. In retrospect, the decision not to rescue Lehman Brothers was probably regretted by the authorities, given the further turmoil it set off in credit markets.

Thereafter, scarcely a single financial institution did not come under speculative pressure, leading to a total drying up of lending between the banks. As a result, banks hoarded cash, spreading the effects of the credit squeeze from the financial market arena to the broader economy.

Economic growth and corporate earnings have consequently come under pressure, intensified by the high oil price that prevailed for much of the summer. Although this has since reversed, it will be some months before the drag from the earlier plateau of high oil prices is offset by lower energy costs.

The early part of October saw the crisis atmosphere worsen, as global fears over bank solvency produced at times near panic conditions. Although Government initiatives to inject fresh capital into the banks appeared to remove the risk of a financial collapse, markets remained under pressure.

The principal reasons were that official remedies for the credit crisis will take time to become effective, hedge funds have been forced sellers of assets as banks have tightened their credit lines and the wider economy is suffering from the aftermath of the toxic interaction between the summer's rise in the oil price and the credit squeeze.

As a result, equities have to weather a period of earnings downgrades as global growth forecasts decline and investors anticipate a period of recession. Eventually, this will end and investors will start to take a view on economic recovery, assisted by a declining trend in interest rates and inflation. In addition, the decline in sterling will boost UK competitiveness and the fall in the oil price should help boost confidence. Equities seem priced for a poor economic outcome that has a good possibility of improving during 2009. Also some equities appear to be factoring in more bad news than others, partly because so much of the recent precipitous drop in markets was driven by forced selling.

In periods of such volatility, it is hard to make rational investment decisions since share prices have been driven by largely technical factors centred on which companies were widely owned by people who had to sell. This information is, unsurprisingly, not published in newspapers. With the earlier fears of financial sector meltdown abating (as official easing measures and injections of capital into the banks have underwritten confidence in the solvency of the banks) and with indications the credit markets are becoming less stressed, we are probably over the worst. The timing of a more optimistic turn in sentiment is hard to nail down, but some building blocks of recovery are falling into place.

Andrew Bell,

Head of Research – Rensburg Sheppards Investment Management