The ‘credit crunch’ hitting the markets as a result of the subprime mortgage lending fiasco in the US is having a significant impact on private investors as they struggle with fluctuating stock. So what should investors do? We asked the experts.

Equity markets have borne the brunt of the scare-mongering, rumour and suspicion currently taking place as a result of global uncertainty when it comes to the market.

Hedge funds too, have seen a rush of investors looking to check out, causing a strain on their position. All of this activity has culminated in banks ramping up the overnight rates they charge each other for the loans they lend one another.

Overnight rates, which typically deviate by a few hundredths of a percent against local base rates have shot up to abnormally high spreads (0.5-0.6%) above base rates. This scale of move reflects the risk aversion of most banks and has threatened the smooth running of the financial system. The rates have increased due to mistrust and uncertainty over creditworthiness of even the biggest financial institutions.

Governments have had to step in to try and lessen the economic problem. Central banks globally, including the US Federal Reserve and the European Central Bank have been boosting ‘liquidity’ or ‘cash-flow’ in the banking system in order to prevent seizure in the global money markets.

The swift intervention by central banks in adding liquidity is aimed to restore normality to lending rates and prevent seizure in the smooth operation of credit markets.

Underpinning all of this uncertainty is a climate of fear regarding the collapse of the sub-prime mortgage lending market in the US.

Subprime lending is big business in the US. Essentially, it is lending money – either via a loan or mortgage – to people who may have a dodgy credit history and are unable to secure conventional loans. As there is a greater risk of customers failing to pay back their loans, they therefore charge more interest.

When interest rates are low, most can manage to repay the debt, but when they start to rise, as has happened in recent years around the globe, lenders can find themselves in increased difficulty. It is defaulting on loan repayments by US subprime loan holders which has led to the current economic crisis.

There is great uncertainty as to how far risks are spread within the financial system and exactly where the losses reside. The market is trading on fear, which makes investors very nervous.

What Investors Should Do

So what should you do? Sell those shares now and get out quick, or ride out the storm and hope the market picks up in the next few months?

"During periods such as this, investors cannot afford to be complacent,” says Paul Niven, Head of Asset Allocation at F&C. “The simple fact is that subprime related concerns are, and will continue to, dominate market anxiety.”

Beyond short term volatility, however, Niven believes that the fact that market sentiment right now is so dire presents an interesting opportunity. In early August Jeremy Tigue, manager of the £2.6 billion Foreign & Colonial Investment Trust, said that investors should ‘start lacing up their buying boots.’ And indeed, many investors have done just that. (Read more: Leading Investment Manager In Call to Buy Stock).

When the FTSE dropped over 200 points on Thursday 26th July, rather than rushing to get out of the market many investors saw it as an opportunity to buy. Barclays Stockbrokers experienced a 16.78% increase in overall equity orders, with buy orders up 18.55% compared to the previous day.

When the FTSE then dropped again on Wednesday 1st August, this also caused orders to increase by 8.95%.

“The art of successful investment is to buy the market when it is weak and cheap not strong and expensive. A mixture of robust economic growth, cheap valuations and high dividend payouts should generate positive returns for investors in UK equity markets,” says Henk Potts, Equity Strategist, Barclays Stockbrokers.

“We recommend that investors stick to companies that have strong, reliable earning streams in defensive sectors. Our favourite sectors are Financials, Mobile Telecoms and Pharmaceuticals. We are cautious on Retail, Leisure, Industrials, Media and Fixed-Line Telecoms.”

Nivens believes that while we may see a further downside in equity markets in the coming weeks, he stresses that from current levels, lead to interest in adding to equity positions at current levels.

In short then, buy wisely now and you could cash in later on in the year.

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