The ‘Credit Crunch’ - Opportunity from Mayhem
You can hardly escape the ‘credit crunch’ on the news at the moment, but why is it causing us problems here in the UK when the issue commenced with the ’sub-prime’ mortgage market in the US?
During the second quarter of 2007, it became apparent that financial institutions around the globe were embroiled largely unwittingly with the problems of the US housing market.
Thousands of US homeowners had taken up fixed rate mortgages at extremely low rates in 2005 when the Federal Reserve had interest rates at low level of around 1%. Two years later when these homeowners came off their fixed rates and went onto much higher loan rates they could not afford the repayments and lost their homes. This, combined with an already over supplied and falling housing market led to the implosion that followed.
So, how does all this affect us here in the UK?
Well, it’s all about the big ‘money-go-round’. You see, banks lend money to each other, but that money is only as safe as the other bank to whom they lend. UK and other banks around the world were lending money to US mortgage companies that had huge exposure to the ’sub-prime’ mortgage market. When the sub-prime bubble burst and those mortgage companies went into liquidation, the banks around the world that lent the money to them lost their money and had to write it off as losses.
Subsequently, banks are trying to raise money to bail themselves out by issuing bonds (and no doubt we will see ‘rights issues’ in the near future), but due to the current uncertainty in the markets they are having to pay a much higher yield to investors. Barclays have recently issued a bond at 8.25%, which is good for investors, but will stay on Barclays balance sheet and will reduce the company’s profits for years to come.
Furthermore, the banks in particular have had billions of £’s wiped off their share prices. You can buy Royal Bank of Scotland shares today at 330p. This is a company that has a history of paying a healthy and rising dividend to investors and over the last year has paid a dividend of 30.20p, which equates to 9% of the current share price. A similar story can be told about many large companies at present.
The point is that the stock markets react on emotion in the short term and on fundamental value in the long term. I don’t doubt that companies will make less profit over the next few years, but with a dividend yield of around 4% across the FTSE All Share right now, there is good value to be had. When the bad news is all out and companies have drawn a line under their sub-prime mortgage exposure, investor sentiment will return to the fundamental good value rather than being swayed by emotional uncertainty.
Although this has been a torrid time for investors across the equity and property markets, it has given rise to numerous buying opportunities for investment fund managers.
Those investors that have the courage to hold tight in the knowledge that their long term investment strategy will deliver, and those new investors in the market, will do well over the next two years and beyond.
We are not out of the woods yet and there may be some more turbulence to go through this year, but the worst is over.