:: : Candour -- advice that fits : ::

Over the past two weeks, stock markets around the world have been falling sharply, as fears grow over the prospect of higher US interest rates. The market upheaval has also pushed down the price of commodities, such as oil and gold, and many currencies. Consequently, there has been nowhere to hide for those with savings and investment policies and we have all seen the value of our policies temporarily drop. Why has this happened?

Some analysts fear the volatility could be a forerunner to more serious turmoil, with a sharp turnaround in expectations about the future course of inflation. Others believe this is simply a ‘correction’ in the market and the effect will be short-lived. Either way, this article should help explain the reasons behind the falls.

There are a number of factors behind the current dip, not least the perception that prices may have been too high in the first place. In the past two years, shares in some companies have risen by as much as a third, prompting the need for a correction as the markets recoil from arguably overvalued stocks.

Commodities are also seen as having overshot the mark, although no-one would deny that there are solid economic reasons for the soaring prices of oil and precious metals. Growth in major emerging markets such as China and India has boosted world demand for crude, which has been at or near the $70-a-barrel mark for nearly a year now. Oil has fallen 6% in the past week, while gold is 4.5% lower and copper is down 5.2%. However, these are modest retreats that still leave commodities trading at a far higher level than last year. Copper, in particular, has risen 85% since 2006 began.

The latest figures from the world's biggest economy, the US, have been concentrating investors` minds in recent days. US consumer prices rose by 0.6% during April, which was faster than analysts had expected. At the same time, US industrial output was also beating forecasts. It surged by 0.8%, raising concerns of inflationary price rises as American factories approach their production limits.

If the US economy starts to overheat and inflation goes up, one way of reining it in is to curb the money supply by making borrowing more expensive - in other words, raising interest rates. The US central bank, the Federal Reserve, is clearly worried about a resurgence of inflation. It has put up interest rates by a quarter-point at each of its last 16 meetings, and investors had hoped that rates would now hold steady at 5%. However, the Fed's boss, Ben Bernanke, is giving little away about his future intentions, and some observers believe his instincts will be to keep prices under control even at the risk of harming growth.

Investors have a choice of destinations for their money, depending on the economic circumstances at the time.

Shares, as any financial advisor will tell you, can go down as well as up, while bonds and savings accounts offer a fixed rate of return and are less inherently risky. When interest rates are low, an investor stands to make more money from shares. But when interest rates are high, bonds become more attractive as a safe haven for your money - so it makes sense for investors to sell their stocks and shift the cash to fixed-rate investments.

There are fears that further interest rate rises could aggravate existing imbalances in the world economy. The record $742bn US trade deficit has long worried the markets, as the value of US imports continues to outstrip the amount that the country can sell to the rest of the world.

The $400bn US budget deficit - the gap between the government's income and its expenditure - also shows little sign of decreasing. And it's not only the US government that is spending too much. The country's five-year housing boom has fuelled consumer spending, which accounts for 70% of US GDP, by encouraging homeowners to borrow against the rising value of their properties. But higher interest rates would lead to higher mortgage rates, putting consumers under pressure and jeopardising the health of the economy.

The experts are split on whether this is the end of a positive ‘bull’ run on the worlds stock markets or whether this is purely a short term correction to bring prices back to a realistic ‘base level’ before growth continues.

Whilst some analysts are convinced that recent market upheaval could be a forerunner to more serious turmoil, with a sharp turnaround in expectations about the future course of inflation and interest rates worldwide, towards the end of last week more and more analysts and bankers were stating that investors were being overly cautious and higher interest rates (if they did arise) would be no reason to see a change in the current trend of rises in the commodities and equity markets.

Unfortunately, we cannot answer this question for you. Without a crystal ball, all we can do is explain what is happening and put the facts before you to decide whether you wish to remain invested in equities or consolidate the gains made over the past few years and switch to funds which are unlikely to be as heavily effected (and may even grow) should the equity and commodity markets fall further – these funds would include cash deposits, bond funds and hedge funds (which are generally ‘market neutral’).

One point we would suggest taking into consideration when making you decision is that downward markets affect single contribution investments (such as Friends Provident International’s Zenith and Generali’s Choice policies) substantially more than they affect regular contribution policies (such as Aviva’s , Friends Provident International’s Premier and Generali’s Vision policies). This is because with a single contribution the value of your investment falls as the markets do and you have to wait for the markets to regain all their losses before your investment regains it value.

However, with regular contribution policies, an effect known as ‘Dollar cost averaging’ occurs in falling markets. Put simply, each month the share price goes down, you can buy more units for each Dollar you invest. Then, when the markets return to a phase of positive growth, the policy holds a lot more units which (as they increase in value) results in your policy producing enhanced returns.

If you feel the markets will not fall further, or you feel they will fall but you have a regular contribution policy and are in it for the medium- to longer-term, then you may be better served remaining in the equity funds of the Candour Consultancy’s balanced and aggressive portfolios.

For those with regular contribution policies who wish to consolidate growth, or hold a single contribution investment and feel the markets are likely to fall further, we have structured additional ‘consolidation portfolio’ where policyholders should be protected from any further market falls.

Provider	Fund	Allocation
Lloyds TSB	USD Money Fund	20%
Generali International	Global Bond Fund	25%
Invesco	Bond Fund	25%
Thames River	Hillside Apex Fund	10%
Momentum	All Weather Liquidity Fund	20%

Should you require further information on suitable funds for your savings plan or investment, just click the ‘contact us’ button below, type FUNDS in the comment box (along with any other information you wish to provide) and submit with your name and preferred contact details.