As the markets readjust to the deepening economic slowdown, Edward Bonham Carter, Jupiter's Chief Executive, comments on ongoing events:

"Fears that the global economic slowdown will be deeper than previously expected combined with persistent concerns over the global credit crisis are resulting in continued volatility on world stock markets.

"A raft of poor economic data and the expectation that more bad news is on the way has been central to the sharp movements we are seeing in stock market indices. The UK economy, for example, shrank by 0.5% in the third quarter of this year, German business confidence declined to the lowest level in more than five years in October while in the US, the Commerce Department is expected to report that the US economy contracted during the third quarter. Sentiment in Asia, which many had believed to be a safe haven in the downturn, has also declined with companies such as carmakers slashing profit forecasts and foreign investors withdrawing money to meet cash calls at home.

"The declining economic environment and continued crisis in credit markets has increased country risk with a number of weaker countries such as Iceland being forced to seek emergency support from the International Monetary Fund (IMF). The Fund has said it will lend Ukraine $16.5bn and will also give Hungary a substantial financial package. Other small emerging market countries are likely to seek support in the coming days and weeks.

"Markets have suffered from the unwinding of  the 'carry trade', under which investors would take out loans in currencies of countries with low interest rates, mainly the yen and the dollar, and reinvest the proceeds in markets where interest rates were higher. Greater weakness in these economies and cuts in interest rates are now encouraging investors to unwind these trades, leading to sharp falls in currencies such as sterling and strong rises for the yen and dollar.

"These trends are being exacerbated by investors, including many hedge funds, who often borrow on credit but are now having to put up more collateral as security against their loans - forcing them to sell assets and pulling share prices down further.

"The strong rise in the yen is having a particularly negative impact on the Japanese stock market. This is because a strong yen makes Japanese exports more expensive and, therefore, less desirable, cutting profits and share prices. There is also a knock on effect for Japan's banks, which have large share portfolios that count towards their capital adequacy requirements. So, as equities have fallen, their capital base has eroded somewhat and the Japanese government is now being forced to lend them money to shore up their balance sheets.

"As the global economy slows the oil price has continued to slide. Some of the worst-hit share prices have been those of oil exploration and production companies. The OPEC cartel met on Friday to agree to cut production by 1.5m barrels a day from November in an attempt to shore up the price. Nevertheless, the oil price fell further, but this should lead to lower inflation.

Rate cuts

"The deteriorating economic outlook increases the likelihood of further interest rate cuts. I maintain my view that UK interest rates could fall from their current level of 4.5% to 3% or lower during the coming year as policymakers seek to avert a prolonged slowdown in the global economy. It is possible that rates in the UK may be cut by as much as 0.5% at the MPC's meeting next week and there is some speculation that rates could even be cut before the meeting. However, this will not significantly alter the fact that in the immediate term, we are now in a world facing lower growth as companies and consumers borrow less.

"As I have stated in previous comments made during this crisis, investors should be aware that volatility in markets is unlikely to reduce until clarity regarding the depth of the global economic slowdown and its impact on corporate earnings emerges. However, I continue to believe that the bleak outlook for the global economy has largely been priced into the value of many shares.

As a result, shares of a number of large companies in the UK seem undervalued and are yielding between 5% and 7%. In the context of falling government bond yields and the likely falls in interest rates, such shares look attractive once concerns over illiquidity in the system subside.

"For those investors who have personal debts or have a short term requirement for cash, I can see the rationale behind a decision to sell equities. I can also sympathise with those who decide to sell because their ability to tolerate volatile markets has evaporated.

Long term investing

"However, those investors who do not currently need cash may wish to look to the long term, as we ourselves at Jupiter are doing. Our fund managers have substantial personal investments in Jupiter's funds and a number of them are taking a long term view and taking advantage of the current depressed prices in order to add to their holdings.

I believe we will see higher equity values from these depressed levels. I am not saying the market will not go lower: it may well do so. But, if one is confident, as I am, that the capitalist system will emerge intact - albeit with less borrowing and more state involvement - then equities present good opportunities for investors taking a long term view.

"The key impact of falling interest rates for many investors will be the requirement to find sources of safe and reliable income. This is why I believe that one of the enduring themes to come out of the credit crunch and market turmoil will be a return to 'back to basics' investing.

In other words, I think we will see a move away from the tendency for investors to chase an apparently high income that has been 'manufactured' from complex, leveraged and ultimately risky structures. These products have proved themselves to be flawed in many respects, with capital often being sacrificed in pursuit of income.

Income investing

In the new world, therefore, UK investors are likely to shift back to traditional income investing. It is worth remembering that over time, the majority of investors' total returns from equities come from dividend growth and the reinvestment of those dividends.

Profit warnings will undoubtedly increase, some companies will have to cut their dividends and the overall yield on the market will fall as some banks put their dividends on hold. But there are still plenty of large, well-managed companies that will be able to grow their dividends and being able to buy their shares on high yields looks significantly more attractive than the returns investors can get elsewhere.

"I have been impressed by the resilience of our investors during this crisis. They have shown no signs of panic and clearly recognise that investing in shares is for the long term. We have also seen many willing to add money to their funds during the current weakness on the view that shares will recover from their current lows. This is an approach we agree with. It is also worth noting that in such conditions, the practice of drip-feeding investments into the stock market through regular savings schemes can prove beneficial.

"At Jupiter, our approach remains to invest in high quality companies with solid balance sheets that have the ability to grow in a difficult environment. It is part of the skill of Jupiter stock-pickers to identify which companies are likely to do well for investors over the medium to long term and emerge from this crisis in stronger positions than they entered it."

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NOTE
The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.