No great hurry to buy

The last few days will have come as a relief for investors, a brief period of reasonable stability after a dreadful February and March. For those two months saw a shake-out in the price of equities and particularly gilts akin to the crash of October 1987. The slide happened more slowly, of course - eight weeks instead of eight hours - but the scale of the adjustment in some markets is of almost the same order of magnitude. And like 1987, the fall has been a world- wide one, led by US markets.

But with hindsight, although the 1987 crash was traumatic, the few weeks after proved a wonderful long-term buying opportunity. What, then, should the long-term UK-based investor be thinking now that the panic has subsided? Grab cheap stock now, wait and try to pick it up more cheaply in a few months' time, or sit out the whole cycle altogether?

The best place to start is with UK interest rates and the implications for gilts. Despite the steadier tone in the last few days, the fallout in the gilt market has been sharper than that of other main bond markets around the world.

This has led to some quirks. Long-dated gilts yielding 8 per cent carry the suggestion that long-term UK inflation will be in the 3-5 per cent region, which is not only much higher than the present level but also carries the suggestion that base rates will be back to perhaps 6 per cent by the end of next year. The adverse movement of gilts has been one of the main reasons many people in the markets are wondering whether the next move in base rates will be up rather than down.

This view will have been reinforced by this week's figures on both the financial side and the real side of the economy. On Wednesday money supply growth (M0) was shown to be rising at an annual rate of 5.8 per cent, way above the 4 per cent top of the official target range. Yesterday industrial production was also shown to be growing more quickly than had previously been appreciated. One could dismiss one or other of the indicators, but together they suggest that a further cut in interest rates is neither needed nor wise.

Of course there may be another cut in UK rates, perhaps two, before the graph turns upwards again, but it would be unrealistic to expect base rates to be as low in 18 months as they are now. The question then is: how resilient will the gilt market be in the face of more expensive money?

There is only one response to that question: it all depends on inflation. If the long-term trend is still downwards, then long-term interest rates of 8 per cent are too high. The gilt market ought to be able to look through a two-year period of rising base rates and see the prize of price stability beyond. If gilts steady and the economy continues its solid growth, there are good reasons to believe that equities are reasonably priced and that little reverses like that of February and March are really buying opportunities.

If, on the other hand, there is enough evidence of inflationary pressure in the near future, then it might well be better to wait until the whole interest rate cycle is past - perhaps until the end of 1996 - before going back into fixed-interest stock. Better to accept a low but still positive return on cash than a negative one on gilts.

The message for equities might be slightly different, for given the strong performance of the economy over the next two years many companies would be able to produce sufficiently strong earnings growth to justify investment now. But the phenomenon of last year, when virtually all shares were pushed up by the flood of liquidity, would be a thing of the past. Markets would be driven by value, not liquidity.

Experience suggests that the inflation outcome will be somewhere in between the optimistic view that it is truly beaten and the alarmist one that a new surge is round the corner. The secular trend worldwide, not just in Britain, remains clearly down, but there may be serious hiccups.

That would suggest that there is no immediate need to rush into either bonds or equities at this moment. Things will go wrong in the months ahead that will create other buying opportunities. But equally there is value in gilts yielding 8 per cent, and in three or four years' time they may look very cheap indeed. As for equities, the recent falls have made it possible to buy much better value than six weeks ago. Wise investors will see the present as a time to start looking for value, but they will not be in any great hurry to buy.