FYI | Aug 16 2007
Let’s start with some positive news. I am sure that after the past two trading days, which saw the local market lose more than 4% in value, and after the market sunk as deep as minus 5.3% at some point on Thursday, most readers, subscribers and investors are up for a healthy portion of positive adrenalin.
The market is likely to move up tomorrow, Wall Street permitting.
The predicted flood of margin calls and technical selling hit the local bourse on Thursday, and most of it will have been absorbed by now. In fact, I have a suspicion that the wave of forced selling petered out in the early afternoon and this allowed the bargain hunters to move back in and reduce the day’s losses.
At some point today the Tech Wizard sent me a chart showing how the market had fallen to what is regarded a key technical support line (50% retracement between low and high earlier this year for the tech heads) and how it swiftly bounced back. This is a major, major support line, the Wizard assured me. I won’t replicate the chart as it was of an awful graphic quality, but it clearly showed how the S&P/ASX200 index had moved in a V-pattern between the opening and the closing bell. The deepest point of the V was near the technical support line.
Another factor that will be mentioned in tomorrow’s newspapers is that the bourse authorities decided to shut down the futures market for about 1.5 hour today. The official mantra from the ASX is: “hardware rectification”. According to sources in the local community this accelerated the selling as brokers were no longer able to hedge their equity positions. Given the shaky state of the market they swiftly decided to sell more equities (as they couldn’t hedge they didn’t want the risk either). With the reopening of the futures market also followed the upper leg of the Wizard’s V-form for the share market.
Another element of good news is that the Australian equities market –some 11% off its high point earlier this year- has now landed in cheap valuation territory. Several commentators had pointed out that the losses until Wednesday had wiped away the valuation premium that had been built up during the bull market of the past few years. The loss of the premium made the Australian share market all of a sudden “fairly valued”.
Pure logic then tells us that another 5.3% off the market by Thursday afternoon had pushed the market from fair value into cheap. Considering that many stocks, even large caps with no link to credit or debt, have lost more than the market’s average over the past few weeks, the cheap value label probably still applies. Wall Street permitting, bargain hunters are likely to have a feast on Friday.
After all, just like share prices don’t climb every day in good times, they don’t continuously fall in not-so-good times.
If you’re not in the game of trying to make a quick buck out of speculating whether Macquarie Bank (MBL) might bounce (just one example, though an obvious one), it’s probably best to look for large, solid companies. Think solid balance sheets, a proven business model, experienced management and a solid track record – no fancy, exotic, or even less exotic financial or debt constructions. And please, no exposure to US housing, US consumer credit or any leverage of both.
This is the message I am picking up from experts and commentators across the market. Defensive/conservative is the new key term. Remember: tomorrow might make for a better day but the world has changed between now and last week, and quite considerably so.
Time to move to the not-so-good news. This whole process of risk adjustment is far from over. Simply dismiss every story that starts with “subprime” from now on, because that is no longer the problem (it already stopped being the problem quite a while ago). What we have experienced over the past eight days was a swift breakdown in trust and confidence. That’s why banks stopped lending to each other. Something they were used to do on a daily basis. All of a sudden they stared at each other and thought: are you going to be the next one?
That’s what makes the current global credit squeeze quite special in its own way: it’s not that there is shortage of cash in the system, but those who have plenty of it are no longer willing to provide it.
This confidence has still to be restored and many people are looking into the direction of the Federal Reserve to do so. Are US interest rates about to be cut? The answer is probably yes, but it is far from certain when and whether this will happen. It all depends on how much longer central banks need to continue providing additional liquidity and how much more bad news will come out into the public arena over the next few days.
As we’ve all experienced since last Thursday, the rhythm of bad news announcements can accelerate very quickly and hit the markets where it is least expected. Now banks in Japan and Canada have joined the ranks of BNP Paribas, Macquarie and Bear Stearns while problems at local RAMS Home Loans seem to get worse on an almost daily basis.
Let there be no mistake: more bad news will follow. And believe me, that is a rather easy statement to make.
Time to focus again on the global economy and it seems but logic to take into account that the current “crisis” (let’s not beat around the bush, what other term can be used when central banks are forced to pump billions of liquidity into the banking system and corporate lenders cannot get any credit anymore?) will start having an impact on what is oft described as the “real economy”.
Everyone who tells you otherwise is either ignorant or not telling you the full story.
As pointed out by some experts in the US, the current credit squeeze is already affecting corporate America. It probably is already impacting on day-to-day banking operations across the globe as well.
But most importantly, and this is an element that has been pushed to the background amidst all the headlines about hedge fund troubles, falling share prices and widening credit spreads, is the fact that US home owners will soon face higher mortgage payments. Not all, but many of them. Earlier this week I stated so-called ARM loans (“adjustable rate mortgage”) with a combined value in excess of one trillion USD are about to kick in from next month onwards. According to some sources, the real figure is about US$ 2 trillion of such loans over the next 18 months.
(These loans typically allow for smaller monthly down payments at first but at later reset dates the interest and thus monthly down payments move up. The effect is obviously larger when the Fed has raised interest rates in the meantime).
It still dumbfounds me that only few economists and share market experts mention this in their forecasts for the US economy. Taken from this perspective, I found it quite remarkable that highly regarded David Rosenberg, employed as economist by Merrill Lynch these days, made the following statement in one of his market commentaries this week:
“We believe the economics community is underestimating what the impact on aggregate consumer spending is going to be now that the home-buying public is going to have to put up a much higher down payment going forward.”
Another factor you will be hearing more about in the weeks and months ahead is Chinese growth. Official statistics, released during the recent share market carnage, showed Chinese industrial production grew at an annualised rate of 18% in July. That is still a very high number. It is nevertheless down from the 19.4% registered in June.
Proof the Chinese economy is cooling down? We’ll have to wait and see.
Another term you will start hearing more often is “food inflation”. While you were all watching Australian shares go down George Weston Foods has raised its bread prices by close to 3% “to recoup record high commodity costs”. This is the third raise in a little over twelve months. One can expect Goodman Fielder (GFF) to soon make a similar announcement.
To conclude this extra bulletin on a positive note, I happily refer to a recent study done by the bond market team at Deutsche Bank. Taking lessons from history, the study concluded that share market corrections usually run their full course before the Fed jumps into action. If the economy subsequently stays healthy this usually opens the door to rising share prices.
What this means, says Deutsche, is that once current market turbulence settles to less extreme levels the local share market could well see some “decent returns”. For all we know, Friday may well be the first day of such turnaround.
Till next week!
Your happy I am finally able to write a more upbeat story editor,
Rudi Filapek-Vandyck
(as always supported by the fabulous team of Greg, Terry, Chris, Joyce, Pat, Grahame and George)
