The World Crumbles

This story features AUSTRALIAN FINANCE GROUP LIMITED. For more info SHARE ANALYSIS: AFG

By Greg Peel

Not such a nice way to return to the Overnight Report for 2008. Greetings and Happy New Year to loyal readers, although there’s not a lot to be happy about right at the moment as, six months later, the world has finally decided the US subprime crisis was no storm in a tea cup as many first suggested. The subsequent bursting of the leverage bubble is now affecting a cleansing of the global financial sector which is proving sharp, painful and unfortunately necessary. Necessary, that is, for a return of focus to the “real” global economy supported by a more sober and sensible financial system and the appropriate pricing of risk. The weak will fall and the strong will survive. Perhaps the good news is that the cleansing is now happening rapidly.

Australia decided to head for the sidelines yesterday despite an otherwise smallish fall in the Dow on Friday. While there would have been quite a few investors and traders returning to work after holidays with selling on their minds, the afternoon session was highlighted by the tumbling of indices across the Asian region. Australia lost 3%, but to the north Shanghai ended down 5%, Hong Kong 5.5%, Tokyo 4% and India 7%. Brazil was also down 7%.

The rout then moved into Europe in its morning session, and with no guide from a US market closed for Matin Luther King day selling continued into the afternoon. London fell 5.5%, France 7% and Germany 7%.

Australia will suffer again today, despite its 2.9% fall yesterday. The SPI Overnight was down 158 points or another 2.8%.

Commentators are laying a lot of the blame for this particularly bad 24 hours at the feet of President Bush, although this does smack a bit of looking for excuses. Bush’s plan to shore up the US economy, yet to be approved by the hostile Congress, is to provide US$145bn of tax relief to encourage consumer spending. Traders across the globe are sceptical of the success of the plan, as well they might be. For starters, such a plan implies there is indeed a problem and that the government is now also of the belief the US will slide into recession. To date, the government has been at pains to suggest otherwise. Just as traders fear a big (eg 75 point) rate cut from the Fed could backfire, as it implies the situation might be even worse than thought, this rescue package similarly portends doom. Moreover, are stressed American consumers going to rush out and buy with their tax relief? Or pay down debt instead? (Not that the latter would be such a bad thing).

More realistically, scepticism of the Bush plan is just another fillip in an already weak market – a market that now looks like a slippery slope of financial industry implosion. Look at Allco ((AFG)) in Australia yesterday and subsequent losses in other Australian financials. The pattern continued across the globe.

Bank of China fell 6.4% in Hong Kong following a report the bank is about to announce a “significant write-down” of US subprime securities. German bank WestLB will apparently post a loss of E1bn for 2007 and write off another E1bn. Rumours are that France’s Societe Generale will also be making major write-downs. Its shares fell 8% last night. Compatriots Credit Agricole (-9%) and Bank Paribas (-9.6%) faired even worse. In Switzerland, UBS lost 5.3% and Credit Suisse 6% while back in Germany Deutsche Bank fell 8.4%. Concerns in the insurance sector, following the meltdown of US bond insurers, saw Allianz fall 10% and ING 10.5%.

About the only bank in the world to buck the carnage was Britain’s Northern Rock, following an announcement from the government it would package its rescue funds into bonds for sale in the market in order to avoid being forced to nationalise the company.

This was the worst day for global equity markets since the day of the 9/11 attacks. And the selling in share markets spilled over into other assets.

Characteristically, gold rallies in times of turmoil. That’s why we’ve seen the metal rapidly rise to US$900/oz recently. But gold rallies are these days a case of two steps forward and one step back, because when the proverbial hits the fan investors must sell out of gold positions to pay margin calls on stocks, or simply to raise the cash lost on stock market weakness. Gold thus fell last night – US$14.50 to US$866.00/oz. Silver fell US50c or 3% to US$15.59/oz.

Talk of recession is not good for hard commodities. Oil fell US$1.92 to US$88.65/bbl while metals also came in for renewed selling in London. While the official London close was weak the selling continued into the later session, with zinc falling 5.5%, copper 4%, nickel 3.5% and lead 3%.

With the carnage in Europe the US dollar held up against the euro and pound but it lost more ground to the yen, finishing at 105.9 yen. This sent the Aussie down again, ending with losses of almost US1.5c since yesterday morning to be at US$0.8617.

In what might otherwise be considered good news, Brazilian mining giant Vale (formerly CVRD) announced yesterday it had been in talks with Anglo-Swiss equivalent Xstrata regarding a possible takeover. Apparently not much headway has been made in the deal which would be worth in the order of US$90bn, and Vale is reconsidering its options (and no doubt its timing) in the face of global stock market carnage. Why rush?

The only sensible approach to a market in this frame of mind is to get out of the way. Only the very brave or foolhardy try to stand in front of a freight train at full speed. It is encouraging, however, that the carnage is swift and not drawn out, as this implies the oversold level will be hit far sooner than some may have expected. An oversold level will definitely be hit at some point, but this is not a time for heroes. There will be plenty of time for rational decisions down the track.

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