Global Markets Weekly - 5th November 2007
Key global market developments
Equity investors get the jitters again, amid sub-prime woes and weak economic data.
After rallying strongly since mid-August, equity markets are suffering another bout of nerves. In the space of two weeks, Wall Street has seen another two sessions with declines of over 2%, as concerns over further sub-prime related write-offs mounted and US economic newsflow came in weaker than expected. Market sentiment wasn’t helped last Wednesday, when the US Federal Reserve (Fed) announced that it has shifted from an easing bias back to neutral.
The current rise in volatility is not unusual.
This is a continuation of the pick-up in stock market volatility since early 2007. So far this year, the US equity market has declined by over 2% in a day on nine separate occasions. That compares with none at all in 2004, 2005 or 2006. A rise in volatility is usual in the latter stages of a bull market, as corporate gearing tends to rise and the earnings outlook becomes less certain.
After further volatility, opportunities should emerge.
Volatility is likely to remain high over the coming weeks. More banks are expected to write off losses and the economic news from the US is likely to remain challenging. That should push down market sentiment to a less bullish level. Once disappointments are discounted in markets – and provided the US still looks set to avoid recession – we should be presented with greater visibility and better opportunities in equity markets, especially as valuations remain attractive, with trailing price-to-earnings ratios at 16.5 times, still around their lowest for 25 years.
Further sub-prime weakness has driven down bank stocks.
The financial sector has led the recent decline, as analysts downgraded some stocks and firms announced further write-downs of assets. The performance of assets backed by US mortgages suggests that more write-downs are to come and, with them, further weakness in the price of financial stocks. Having recovered around half of their summer fall, the AAA-rated ABX indices – which measure mortgage-linked assets – have started to make new price lows over the past couple of weeks. This will put further pressure on the asset side of banks’ balance sheets. All of which means that bank credit availability is unlikely to improve – indeed, will probably worsen – in the short term. So, over the coming months, banks are likely to be less willing to lend to households and companies, which will act as a drag on economic growth.
The Fed slips into neutral, pending further data.
The statement that accompanied last Wednesday’s cut in US interest rates from 4.75% to 4.50% said that, “after this action, the upside risks to inflation roughly balance the downside risk to growth”. In other words, unless the incoming data releases signal a net increase in downside risk, the Fed thinks it is done. This shift from an easing bias to a neutral stance increases the Fed’s policy options. It probably hopes to avoid cutting rates again this year, but weak activity data could easily push it into cutting early in the new year. That would continue to undermine the dollar, particularly against the euro and the yen.
Judging by forward-looking indicators, further rate cuts may be needed.
A taste of what may lie ahead came last week, with weaker-than-expected house price data and consumer confidence figures. The purchasing managers’ survey slipped from 52.0 to 50.9. It’s not yet below the 50 level, which the Fed is very sensitive to, but it is heading that way. By contrast, payrolls and third-quarter GDP came in stronger than expected. Yet both of these series tell about where the economy has been, rather than where it is going.
Indices, Interest rates and Inflation
|
Close 2-Nov-07 |
1 Week% |
1 Month% |
3 Months% |
YTD | |
|
FTSE ALL Share |
3,362 |
-1.8 |
0.7 |
3.2 |
4.4 |
|
FTSE 100 |
6,531 |
-2.0 |
0.5 |
3.7 |
5.0 |
|
S&P 500 |
1,510 |
-1.7 |
-2.4 |
2.5 |
6.4 |
|
Nasdaq Composite |
2,810 |
0.2 |
2.3 |
9.1 |
16.4 |
|
DJ Stoxx (Europe) |
424 |
-0.8 |
-0.2 |
2.4 |
7.3 |
|
Nikkei 225 |
16,517 |
0.1 |
-3.1 |
-2.8 |
-4.1 |
|
Hang Seng |
30,468 |
0.2 |
8.0 |
35.8 |
52.6 |
| Official Rates (%) |
Inflation (%) |
Rate announcement | |||
|
Current |
Dec-07 Forecast |
Mar-08 |
Current |
Next Date | |
|
US (Fed Funds) |
4.50 |
4.50 |
4.50 |
2.8 |
11-Dec |
|
UK (Base rate) |
5.75 |
5.50 |
5.25 |
1.8 |
08-Nov |
|
Euro-zone (Repo Rate) |
4.00 |
4.00 |
4.00 |
2.1 |
08-Nov |
|
Japan (Call rate) |
0.50 |
0.50 |
0.75 |
-0.2 |
13-Nov |
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