Justin Urquhart Stewart: Summer slump or summer sale?

Should you be buying in or selling out right now?

Well what a week. We all know markets don’t carry on up in a straight line and there was always going to be a pull back at some stage, but as ever, nobody ever knows quite when it’s going to happen. The ‘why’ bit is a little more predictable in that we can see some of the issues ahead of time, but it is always going to be difficult to judge the impact on value and confidence.

Firstly the withdrawal of Quantitative Easing (QE) and the resultant stimulant induced financial highs, was always going to pose a threat of financial cold turkey and the consequent market nerves. But of course QE hasn’t actually been withdrawn or even cancelled, it’s just that good notice has been given. However, the Feds are no fools and the last thing they are going to do is endanger recovery by changing policy too soon. Bernanke’s knowledge of the Depression will have given him some clear examples of how not to do it. The rate rise and government expenditure cuts in 1937 are the obvious example – these actions threw the US significant economic recovery back into recession.

So the initial knee jerk reaction from markets was to be expected but the scale of the effect in the emerging markets has really been rather dramatic – both in their equity and bond markets as well as certain local currencies.

However, what was not properly recognised in the media was the amount of leveraged and margin trading that had been built up – especially in the US – and thus, as markets fell, calls were made on borrowers to maintain their collateral. This inevitably has a knock on effect as forced sellers will often trigger lower prices.

But once the popular furore was over, it was interesting to see the reaction from most sound investors as markets stabilised and the talk was of buying in – not selling out. Compare this attitude of mind with just three years ago. Back then there were many who were looking for reasons to sell out, and such volatility just underscored their fears. Now contrast that with today; many see such volatility as a reason to buy and to look at such dips not as a summer scare but rather more of a summer sale.

Another area of fear has been coming from that putrid smell emanating from the deeply suspicious Chinese shadow banking system. In fact a lot of the Chinese banking structure has been regarded with concern for some time, as much of it is opaque and suitably inscrutable. There have been worries over the secure nature of many of the banks for some time. So just add to that a helping of corruption, a few fluid ounces of political interference from the Communist Party, a mere teaspoon of effective regulation and you have a recipe for a beautifully presented financial fiasco at some stage. Season this with an accounting system that could have written by Edward Lear and we have a Chinese banquet fit for nothing.

In many ways I think we should be more concerned about the risks within China itself than the frets of traders having their financial heroin being threatened.

So what is the main message from all of this? Don’t get panicked by short term traders causing market volatility. The global economy is still growing, and even healing from some of the worst of its injuries, but many painful sores will still remain.

I will be searching for some bargains this summer.

Justin Urquhart Stewart is the founder of Seven Investment Management and a regular media commentator. Originally trained as a lawyer, he has observed the retail market industry for 30 years whilst in corporate banking and stockbroking.