What will this latest correction mean to you?

In this column I try to cover a range of financial subjects of general interest to investors and savers alike, including those who want to plan for the future and protect themselves against risk. The main areas should be financial markets, financial products and financial planning. But every time I sit down to write about the last two, a major event occurs in financial markets that I cannot possibly ignore. Such an event has occurred over the past few days leading up to February 5 (the day I had set aside for writing about financial planning issues.) Namely, equity markets dropped back significantly, wiping out most of the gains built up since November of 2009.

So here I am, back again, writing about financial markets. The 10 per cent correction is the market's response to several events. First, central banks have indicated that they will be reducing the flow of cheap money into their economies. This means there will be less investment, less consumer expenditure throughout the world and hence reduced prospects for business activity and, ultimately, profits. China has already started to implement such policies by placing restrictions on what its banks can lend, and the Bank of England is pausing before winding down its so-called quantitative easing programme. In the UK, there is also a general election on the way, with expectations of more fiscal tightening. The implication is that the economy will remain weak, and government revenues will be low, so the scope for using monetary policy to continue fuelling the markets will be limited.

Secondly, there are several countries that look as if they might default on their sovereign debt. Chief among these is Greece. Fear of a Greek default has led to wide speculation about the consequences for the eurozone as a whole, but there is also a view that Greece will not be allowed to fail. As a result, some fund mangers see this as an opportunity to buy Greek bonds while they are under-priced. They believe that the contagion that followed the collapse of Lehman in the US will not be allowed to happen in the euro zone.

Nick Gartside, for example, the Schroder ISF Global Bond fund manager, reported to Citywire two weeks ago that he had been adding Greek debt to his fund. He believes that Greece is not going to be pushed out of the European Union and that their bonds are therefore a good buy. And while Greece is under the observation, Spain and Portugal with potentially worse problems are in the waiting room. In response to all this uncertainty, on February 5, the FTSE100 fell 92 points, or 1.8 per cent, to 5046. Shares had fallen nearly nine per cent from their January peaks to levels that had not been seen since the beginning of November. There had been significant moves by investors, over a three-day period, to reduce risk with defensive tactics such as buying the Yen and US Dollar and selling riskier equities such as the mining and banking share, both of which suffered heavy falls.

By midday, the pound was down against the dollar at US$1.5725 (Dh5.76) and the euro was down against the dollar at $1.3708. To make matters worse, the cost of insuring sovereign debt (commonly known as credit default swaps) increased substantially even among the developed countries which reacted unfavourably to the Greek governments proposals for dealing with its repayment obligations. Price variability in equity markets, as measured by the Vix volatility index (or the "fear index" at it is often known), increased rapidly by an enormous 20 per cent in a single day.

Not all the news was bad news. On hearing the latest US job figures that reported 20,000 jobs lost in January, equity markets initially fell back but recovered when it was realised that at 9.7 per cent, unemployment was not as bad as the 10 per cent figure that had been previously forecast. So what does all this mean to the average investor? Are we witnessing a healthy correction from which markets will start to grow again, or are we heading towards the second half of a "double dip" (the first dip was in February/March 2009). The truth is nobody really knows - except fund managers, of course.

Richard Buxton, the head of UK securities at Schroders, as reported by Citywire, is relaxed about the latest market falls, describing the sell-off over the past three days as an overreaction by investors. So confident is he that markets will return, he is using the opportunity to buy into a wide range of stocks with a view to gaining from a strong performance over two years. Here's my advice: if you have a lump sum to invest and are wary about the markets, divide it into 12 equal parts and invest it monthly over the next year. Sometimes you will pay over the odds and sometimes you will get a bargain, but on average you will pay a fair price. But do not expect to make money over a short period. Instead, look forward to growth over five to 10 years. If you are already making monthly contributions to a long-term plan and have an appropriate asset allocation, just keep making the payments, relax and go to the beach.

Bill Davey is a financial adviser at Mondial-Financial Partners Dubai. Write to him at [e-mail]