As the UK finally pulled out of a bear market, there are hopes that the price of oil may have bottomed out. Hopefuls are warned against diving back in, however, as the rally seems dubious.
 
    As commodity prices lowered, earnings dropped causing the fall in shares. If the earnings recession continues, it means shares will continue to decline.
 
    The world economy has largely been built on debt and in the past two decades that debt level has risen to cause the biggest threat to shareholders today.With the fall of profits, interest payments on those debts may never be repaid. Ultimately, equity holders may be left with worthless pieces of paper.
 
    At the moment, banks are unwilling to call in their loans as they are still in recovery from the last crisis. However, a real correction in corporate credit would be painful indeed.If the situation worsens in the year ahead, the process of foreclosing on loans could soon begin.
 
    The underlying cause
 
    China’s slowdown in production and tumbling oil prices largely contributed to the stock market decline over the past six months. The decline in profits have deeply affected mining and oil companies in the UK, in turn dragging down the wider market.
 
    An extended recession could cause a wave of defaults on debts that have built up. It’s quite possible that there will be an acceleration of asset sales by commodity dependent sovereign wealth funds.
 
    Asset markdowns
 
    Last year eight FTSE 100 firms slashed payouts, making it a questionable situation for dividends. Profit forecasts have been cut back by management teams but asset markdowns take more time to go through. Once the auditor agrees that the situation is not likely to recover, all that is required of a company is to write down the value of an acquisition. Annual results due in February and March will decide what companies will bail.
 
    Although there may be shares that have fallen by 40pc and are trading at discounts, investors should be very wary. If most of that asset value is attributed to past performance, any true value in the shares could prove to be an illusion once the particular company writes down its assets for the year.
 
    Restraint may be wise
 
    It may be tempting to dive back into the market when shares drop during the sell-off. Normally buying wouldbe the right move. However, the situation we have today could be something unfathomably worse than what we were prepared for. There’s a high risk to shareholders. Cheap credit is at the root of previously soaring equities but when debt becomes more expensive, all those gains will be undone.
 
    At this point in time, it wouldn’t hurt to hold onto more cash than usual. After all, we are living in a world where what’s hanging in the balance is a fundamental element of equity valuation. We’ve enjoyed nearly seven years of a bull market but, all good things must come to an end.