How To do It: Balance of equity mart meltdown

Although a reduction was expected earlier in the month, Alan Greenspan surprised the market by cutting rates half a per cent rather then the 25 basis points that had been widely forecast. This aggressive reduction saw the federal funds rate plunge to 1.25 per cent, a sure sign that the authorities fear a stalling in economic recovery.

The U.S. Federal Reserve has to perform a fine balancing act to ensure that inflationary pressures and the obvious economic weakness are not adversely affected by these rate cuts.

There is no doubt that in turbulent economic times cash is king. It has been estimated that in quarter two of this year alone global equity markets shed almost $800 billion. Since June, the situation has got no better and nervous investors are still dumping shares.

That being the case, what has happened to this cash surplus? Some of it has indeed been channelled back into the markets via corporate bonds and also it has been invested in the burgeoning real-estate sector. However, the amazing fact is that some 35 per cent of this cash (or over $280 billion) has found its way into the world's bank vaults.

Again experts will pontificate that this is dead money and not adding any value to the world's economy.

However, no blame can be laid at the feet of the investors who are rightly not happy with certain investment sectors and who consider putting their hard-earned money in the bank as the safest form of investment. But the downside for them is the meagre returns as a result of these historically low interest rates.

Now what may prove interesting to the Gulf-based investor is to see where the balance of this equity market meltdown has gone. On a global scale, 26 per cent has found a home in the property market, 22 per cent in government bonds, 13 per cent used to repay debt and four per cent has gone into hedge funds.

Further analysis shows following regional returns (below) in percentage terms.

One of the major reasons for the property market boom in the UK can be seen from the fact that so much money has left share markets and has been reinvested in real estate. Before jumping on to this bandwagon, the cautious investor should ask what will happen when the money starts flowing back into capital markets.

There are those around who consider that this recent property boom could end giving investors the same problems, and loss of investment, as the dotcom boom of the late nineties. Maybe this particular bubble is just waiting to be burst.

One inescapable fact of economic life is that if the price of any asset is wrong there is no way that the market can stop the price falling, no matter how low the interest rates. That must act as a warning to all those who currently think that real estate is the panacea for all their financial woes.

For an economic recovery to take place, more and more money should be made available for the corporate sector. It is here that real value can be added and there will be no global improvement until money is channelled back into productive investment.

So the world is in a major Catch 22 situation. Why would individual investors, let alone insurance companies, pension funds and other financial institutions, invest in the corporate sector?

It would be no surprise to many, and it would be a worry to others, if there were no more accounting scandals, bankruptcies or a further downturn in markets.

No wonder the American economy is reeling when its share markets lose $400 billion in three months and sees the Europeans alone repatriate nearly $60 billion over the same period. Not to be outdone, the Americans themselves have brought back over $100 billion, mainly from Europe.

As the global economies lurch from one crisis to another, the Gulf-based investor has been hit again by the recent cut in interest rates. The already meagre returns he was getting have been slashed once more.

As rates fall, the investor has to look for new avenues. Unfortu-nately, these days, they all appear to be cul-de-sacs.