Financial World, 1st December 2007

Financial markets are inherently unstable, says Andrew Smithers, and the view that corporate balance sheets are in good shape is an illusion.

Financial markets are liable to shocks in many forms. Political and economic events are by no means the only ones. Financial markets are inherently unstable and, as we have seen recently, can cause their own shocks. Data surprises are another possible source of trouble. Investors can be frightened when information, which they had previously seen as certain, proves to be illusory.

The belief that “corporate balance sheets are in good shape” has the perfect qualities for providing future shock. It is widely held as an article of faith and is probably wrong.

The illusion depends on high asset prices and will probably continue as long as they last. Asset prices are thus unlikely to start falling because investors suddenly become alert to the issue. It is more probable that they will only realise that corporate balance sheets are over leveraged when asset prices have already fallen. The ill judged faith in corporate balance sheets is thus likely to crumble with share prices and thereby amplify the size of the fall…………..

Full article: False Impressions – Financial World Dec Jan 2007-08 which was published in the December January 2007-08 issue of Financial World