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"There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns - the ones we don't know we don't know."

- Former United States Secretary of Defense Donald Rumsfeld

Yes the joy of clear and concise rhetoric. I am sure he knew what he was talking about but I suspect that most of the audience listening to his oratory were totally baffled. Once though you pick your way through it, you can sort of understand what he means, even if the line of argument is somewhat tortuous.

So if I may take his somewhat circuitous language and apply it to what is happening in our markets, I hope I don't make things as equally confusing.

The key issues of concern around the current market madness seem to have been in three areas. Firstly that of the US debt and deficit. Secondly, the concerns around the structure - and even the future - of the Euro. Thirdly, the worries of a lower, slower global economy. So in Rumsfeld terms these are all "known knowns". The US deficit story is hardly new, but of course it has been the action, or rather inaction by the authorities to take any effective and credible decisions to address it, that has been the real source of concern.

The actions needed to manage it are all understood - at its simplest - the US government needs to spend less and earn more, but of course no politician is going to be brave (or is it foolhardy) enough to come out with such policies before the elections next year unless they absolutely have to.

As for the Euro, the sad story of a glorious concept being badly implemented continues. Again the issues of elections are influencing this, with the main protagonists of Mrs Merkel and President Sarkozy both nervously facing the electorate in the not too distant future.

The slowdown in the global economy has also been signposted for some time, with the imbalances of the indebted Occidental nations and the flush Oriental ones needing to be managed out over time.

So if we knew all of this, why did the markets get into such a frenzy over August? It can't just be related to holidays! The main element comes down to that key word for all economies and markets - confidence. This was virtually nothing to do with confidence in companies, many of whom have been doing rather well of late with lower debt levels, higher cash positions and healthy profits. No, this has been all about confidence in our leaders. Not so much about them being seen to be taking action and all rushing back from their holidays for macho photo opportunities of them being seen to be "in control", but rather their ability to come out with credible decisions that would address our "known knowns".

Some sanity only returns when more logical thought comes in and looks at the companies making up these volatile indices and realises that political ineptitude does not directly correlate to stock market valuations. Yes, certainly some future corporate expectations maybe over-optimistic but certainly not enough to require such a share price fright.

Which brings up the question then of the actual valuation of the indices themselves? The trading brokers bicker amongst themselves as to what calculations they should follow. The Bulls say that current price earnings ratios mean that shares are "cheap" (a word I especially hate as there is little appreciation of value), whereas the Bears point to the Cyclically Adjusted Price Ratio (CAPE) highlighted by Robert Schiller. This method attempts to smooth out the volatility of cycles by dividing the price by the average ten years of earnings per share. Thus on this basis the ratio would imply that by taking measurements from 1881, US stocks are overvalued by 23%, and on a shorter measurement from 1945 overvalued by 11%. Which is right? Only time will tell, but the CAPE is not a short term trading tool but rather a measure of longer term historical influences and probably giving a better indicator of when markets are undervalued rather than necessarily marking the tops.

So what situation are we in? I have mentioned before the almost biblical ten years of fat followed by ten years of lean, but my old friend and ex-colleague Antony Peters correctly pointed out that it was probably more likely to be even more in the style of the Old Testament in that it is likely to be seven years tracking back to the actions of the Fed post "9/11" to stabilise the national fears after the terrorist attacks and avoid the forthcoming recession. Did this action really set alight the boom that led to the bust seven years later? And thus are we three years into our seven years of lean? Quite possibly, as it would be hoped that in four years there should be some improvement. Yes - but only if our politicians can credibly address our "known knowns".

So is it a recession we are facing or even a depression? Both are unlikely, but rather I suspect a period of economic anaemia which for some will certainly feel like a recession. Some have called it the "Great Contraction" as the balance of overcapacity and falling demands eventually finds its correct level. And what shape? V or W or bath shaped? - no probably like a swimming pool - down at the deep end flat for a bit then slowly rising - and giving us all a good dose of chlorine at the same time.

As Autumn begins so we enter the season of not just mellow fruitfulness but also Autumnal gales. Be prepared for both, but with the view that you should look through such events to the longer picture of eventual repair and recovery.


Next Sunday is an appalling anniversary when the stuff of fiction became reality. A chance for us to recall the horror and to remember not only those who died, but especially feel for those they left behind.


And finally... another tax solution to balance the nation's books - is this something we could learn from the Germans?

It seems that a new initiative has been introduced in the German city of Bonn whereby prostitutes must carry a ticket purchased from a new parking meter-like machine while working the streets or face hefty fines from tax authorities in a scheme launched on Monday night.

In Germany, ladies of the night pay income tax - the level of which varies from region to region - but compliance is difficult to enforce with women seeking business on the street.

Germany's first "sex tax meters," from which prostitutes can purchase a ticket for 6 Euros per night, will ensure the tax system is fairly implemented, a city spokeswoman said. "Inspectors will monitor compliance - not every evening but frequently," the spokeswoman told Reuters.

If caught without a valid ticket, offenders will first be reprimanded, and then face fines and later even a ban. About 200 prostitutes work in Bonn. Due to protests from residents, city officials have limited the areas of operation to specific quarters. But critics say this has made it easier for prostitutes to ply their trade. The city has erected what officials call "consummation areas," wooden parking garages where customers driving cars can retreat to with prostitutes.

I can't see it solving our deficit immediately, anyway what a waste of money - they should just use our Oyster cards.

Have a good week.

Justin A. Urquart Stewart
Seven Investment Management Limited

This article represents a personal and light-hearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777. Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.

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