The financial crisis is now deepening with serious consequences for economies worldwide.The financial shock in October has intensified the credit crunch and has triggered a sharp economic downturn. The crisis has involved over-leveraged banks and the shadow banking system. As a result, the world will return to a more conservative banking system based on deposit taking.The process of credit contraction will take time, leading to further instability in the financial sector amongst those banks, hedge, and equity funds.Tougher regulation, write-downs, and emerging market risks will remain problems for the financial sector. Since valuations are neither trustworthy nor compelling, we remain underweight financials.Fortunately, unilateral responses have now given way to a coordination of policy amongst central banks - providing liquidity, recapitalising banks and cutting interest rates. These measures will cushion economies, but further financial support and more expansionary stimulus will be necessary. Equity markets reached a multi-year low in October with the FTSE down 10.6%.Our defensive market stance offered no protection because our overweight positions in Prudential, Xstrata, International Power and John Wood Group underperformed.The Fund fell 13.3% during October.
In this unprecedented crisis our strategy is to wait for clarity. Although equity markets have now repriced risk and revised expected earnings, the return of activity in credit markets is a more reliable guide for a recovery in equities in the short term.