The end of the world as we know it? Or the greatest buying opportunity in a generation?

The last couple of months have been truly hectic, such that I now feel glad just to have made it to the weekend.

Observing what is going on within the financial sector has led me to conclude that it is almost certainly the end of the world as we know it as far as banking is concerned. By all accounts the problems within banks are now starting to spill over into the real economy, with business is some parts of the economy pretty much grinding to a halt. The authorities now seem to really "get it", as was clear by the Brown and Darling plan announced earlier in the week. It is only a matter of time before the US goes down the same route. Perhaps something will come out of the G7 convention this weekend. Indeed one has to hope it does, for this is truly the first global financial crisis, the one that all the academic books warned of, the one that the current national system of regulation would not be able to deal with. Some sort of global coordinated response on a scale larger than seen so far is probably going to be necessary.

Unfortunately (or fortunately!?) for the banks, I think this is most likely to mean a complete sea-change. Now that the authorities are aware of the risks posed to the real economy they will not stop until the problem goes away, even if it means complete nationalisation, firing of all directors and senior management and replacement with regulatory bureaucrats. If the banks don't start lending to each again on their own then I think this will be what happens.

Yet when I look at stock market valuations, I cannot avoid the conclusion that this could well prove to be the greatest buying opportunity in a generation - much like 1933 or the early 1980s. Long term valuation metrics would certainly suggest so. For example, the Graham-Dodd 5yr p/e for the European market is currently at 11.7, only slightly above its historical trough of 9.8, and well below the average of 18.6. Admittedly, using 10 year data would probably be less favourable but the conclusion still holds. The US market looks less cheap on this measure, although still well below its long run average. Tobin's q - a measure of market value of assets versus their replacement cost - currently stands at 0.5 for the US market, versus its 50 year trough of 0.4

Before this week, the FTSE 100 was trading on a 2009 p/e of around 10X. So after this week's dramatic move, it will be down to around 8X. For sure the "e" for 2009 is wrong (too high), but even correcting by 30-40% still leaves the market looking far from expensive.

The sector I focus on (media) has some pretty resilient companies trading at what looks like absurd valuations. For example all the advertising agencies are on huge discounts to their historical valuations - 50% off trough multiples. Perhaps the long term future is not as bright as it was in the past, but these business services companies are not going to disappear, and neither are companies going to stop advertising. Earnings will almost certainly fall next year, but this is more than priced into the shares already.

Opportunities are being thrown up in other sectors too. The recent move down has been driven heavily by industrials and mining, sectors that had previously been holding up OK. Some defence and engineering companies such as Cobham and Meggitt are on multi-year valuation lows. These business have many highly defensive and long-term revenue streams. Within financials asset managers (Legg Mason, Ashmore) also look exceptionally cheap. Despite what markets are doing, people are not going to stop needing their assets managed.

All of this leads me to conclude that now is actually a fantastic entry point for any unleveraged investor with a reasonable time horizon (i.e. more than 2 years). Indeed, this is actually a natural part of the credit cycle. Despite all the media hype surrounding this crisis, it is actually following all the normal stages of a credit cycle (all be it on a slightly grander cycle). What we are witnessing now is a great de-leveraging, as all the excesses of the past few years are unwound causing asset prices to fall. With money markets not really functioning, the equity market is currently the only liquid market. This means it is suffering particularly badly as leveraged market participants facing margin calls or debt maturities become forced sellers. It is natural in such an environment for unleveraged market participants to enter the market, pick up a lot of bargains, and in the process restore the market to fair value.