| Credit markets crisis continues |
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| The signs are increasingly showing that credit markets are closed again. This augurs badly for risk markets. Panic in credit markets rarely if ever is a positive for shares and property in general. The result, when combined with the commodity crisis, could and probably will, result in further substantial drops in shares and property values from current levels. Rallies will occur, writes Tony Keogh of Trinity Financial Services. |
August 2007 was the start of the credit crunch, commonly referred to as the sub-prime crisis. It started, as usual, with the financial operators because that’s where the banking system generates leverage for the rest of the economy.
The credit markets effectively closed in January 2008. They reopened somewhat in April and May. The signs of another panic, as seen in January, have re-emerged. Again in May we saw a record inflow of funds into corporate bonds. Part of this money was leveraged but is now showing losses. These losses are likely to result in margin calls over the next few months as in February/March following the January closure. So the credit crisis is re-emerging just as many market participants had come to the conclusion the worst was over.
Credit derivatives have been worsening since mid-May. So as money was coming into the actual credit markets in mid-May the credit derivatives were worsening. Such a divide is a recipe for volatility. Either the bulls (the positives) or the bears (the negatives) are going to lose out badly. It is now evident the bears have won out and ‘margin calls’ are likely to follow.
The Federal Reserve may act again but firstly they have to recognise that the major problem has re-emerged since only a couple of weeks back they said the downside risks were decreasing when in fact they were increasing.
In the likely event of the credit panic re-emerging risk markets are likely to fall heavily.
Risk markets have fallen from their highs mainly over the past year. It is worth considering the declines in terms of previous bear markets (sustained drops). Equities (and property) are risky and poor years are common. The London Business School database which spans 17 countries shows that historically 38 per cent of all one year real returns are negative. Two bad years is not especially unusual. Historically two year runs of negative real returns have occurred in 16 per cent of all two year periods. Even three year runs are not unheard of having occurred 6 per cent of the time since 1900.
The falls in share prices from their highs during this bear market total can be split into divisions of minus 40 per cent plus, minus 30 per cent plus, minus 20 per cent and single figure falls. The largest division category of falls comprises Ireland, India and China and Japan. That Ireland tops this category should come as no surprise given the diabolical economic policies pursued over recent years. Moreover, the Irish market started to decline from its high on 21 February 2007, long before other markets (with the exception of Japan) commenced their descent.
The minus 30 per cent plus category comprises international property, North America and the Pacific Basin markets whereas the minus 20 per cent plus is comprised of UK small companies and equities and UK property together with European Equities - down 24 per cent from its peak. The non-risk category – Government Bonds – stands alone in the single figure category of falls with a drop of 7 per cent which commenced only in March this year. All of these changes in indices reflect purchases made in Euro.
The comparisons with pronounced bear markets are as follows:
• The most recent was the technology bubble crash, started at the beginning of 2000 and ended on 23 July 2002. This bear market saw 40 per cent falls in the UK and Japan, 47 per cent in the US and 49 per cent in Germany.
• The first oil crisis in 1973/1974 saw shares drop by over 50 per cent in the US and over 70 per cent in the UK.
• Share prices fell by over 80 per cent during the 1929/1932 crash.
There are increasing similarities and differences between the 1973/1974 oil crisis and now.
Then it was very difficult to get oil/petrol at any price whilst credit was available at a high price. Nowadays credit is largely unavailable at any price whereas oil/petrol is available at very high prices.
Oil (and I use this as a synonym for all commodities) is far above the price reached in 1974 but the real comparable price of oil - the cost to produce a unit of economic output – is estimated at $170 a barrel. The price is getting closer almost by the day.
So the dilemma facing authorities is real, namely the credit de-leveraging process can be halted via monetary easing but this is complicated by the commodity shock and the monetary response thereto.
Meanwhile pressure on profit margins and real income are likely to continue for the foreseeable future. The outlook for economies and risk assets remains grim, really grim.
As the Bank for International Settlements stated in their annual report just published:
‘Fears are building that the global economy might be at some kind of tipping point. These fears are not groundless.’ |
Tony Keogh is managing director of Trinity Financial Services.
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| Article appeared in the July 2008 issue.
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