Today’s relief rally is
definitely a relief but it would be a mistake to think that the risks have
disappeared, or the volatility for that matter. Now is the time for investors to
think about risk and what it really means, and one thing it doesn’t mean is
volatility. But don’t be misled into equating the two as many so-called experts
do – they are not the same things at all.

Yes, market volatility is upsetting and feels risky,
and has lately increased towards more normal levels after several years of
straight-line, low volatility growth in share prices. That’s happening because a more
normal level of uncertainty about interest rates has entered the equation. For
two years the Federal Reserve Board has been increasing interest rates at a
“measured” pace, as former chairman Alan Greenspan used to say. It was a one way
bet. Now no-one really knows what’s going to happen beyond June. Uncertainty =

that’s not risk. Risk is the prospect of losing your money. Ups and downs are
trading opportunities if you’re a trader, and nuisances if you’re not. But
losing so much money that you won’t get it back before you retire and therefore
need it … that’s risk.

I believe we have had, and are still having, a
correction during a continuing bull market and that on the whole, the market is
now back to roughly where it should be. If you took our advice and saw it
coming, and prepared for it by selling some of your most overvalued stocks, then
you should be getting ready to do some buying.

We think it’s unlikely that this
time the losses will be recovered very quickly. Morgan
Stanley analyst Mark Skocic says he thinks the market is now fully pricing in
the macro risks because the emotional shift in market views has, on his numbers,
seen the market P/E “de-rate” by 6%, from its May peak. “The present market P/E
is at a 9% discount to its 10-year average (ex the effect of tech boom), so the
plus of this sell off is that risk-based pricing may have returned. Buy quality
in times of volatility.”

Methinks Mark may be making the mistake of mixing up risk and
volatility. His last sentence is absolutely right, but I’m not sure the market
is now fully pricing in the macro risks. The more substantial risk is that
global interest rates rise significantly, either because central banks go too
far or because inflation surprises on the upside, causing a big decline in
property values and a global recession in 2007. That would stretch the recovery
in share prices out from three months (in our view) to more like 12 months –
until central banks start cutting rates again next year.