One year on, we are wiser but poorer

One year after the credit crunch began in earnest and what have we learned? Three simple lessons: the UK and US housing markets were indeed overvalued, as many people had argued; the finances of our banks are not as sound as we thought they were; and that the financial system is not as robust as we thought it was.

From this, we can see two further important facts. The first was that emerging markets could indeed decouple from the US economy. But the result of that decoupling – a continued rise in commodity prices when the US economy was already slowing – was not actually that beneficial. The second was that central banks will go to great lengths to rescue the financial sector, even at apparent cost to their commitment to fight inflation. US rates, at 2 per cent, are three percentage points lower than headline inflation.

Thus we are wiser one year on, but poorer. Our houses and our investment portfolios have fallen in value. Our household budgets have been squeezed by higher petrol prices and utility bills. It is hardly surprising, in the circumstances that the government is so unpopular and there is talk of ditching Gordon Brown. When a government claims credit for a long period of economic expansion, it can only expect to get blamed when things turn down.

Looking back, there are a few more specific lessons that will be of use to investors in the future. The first is to beware when any sector becomes dominant in the US stock market. In the early 1980s, it was energy; in the late 1990s, it was technology; in the early 2000s, it was financials. The trigger point seems to be a weighting of more than 20 per cent in the S&P 500 index.

The second lesson is that equity investors cannot afford to ignore the credit market. Credit spreads started to decline in late 2002, before the UK stock market bottomed in March 2003. In the first six months of the credit crunch, there was a feeling that the equity markets were somehow immune from the problems of the subprime housing market. But now the bad news has spread: most equity markets round the world have suffered a 20 per cent decline from their peak. The chances are, therefore, that a buy signal for equities will be generated if corporate spreads fall significantly.

The third lesson is that strength in emerging economies does not necessarily lead to strength in emerging markets. The sector may have improved an awful lot from 10 years ago; it has returned an average 13 per cent a year in real terms over the last decade. But some of the markets got overvalued in the euphoria of 2007 and there are definite signs of overheating in some of the economies.

Traditionally, emerging markets were a leading indicator. As a risky asset, they tended to fall in advance of developing markets. This cycle, they have been a lagging indicator. In turn, they seem to be driving commodity prices. July saw the biggest monthly decline for raw materials prices in 28 years, with a 10 per cent decline, according to the Jefferies-Reuters CRB index. It looks, finally, as if high prices might be having an effect on demand.