Take a
look at news headlines and reaction to events in the US this week
and it’s clear uncertainty about world markets has increased.
Chris
Caton is Chief Economist for the BT Financial
Group
I have
to be honest and say I was a touch too confident that the credit
market issues would slowly improve. Instead, things have clearly
got worse.
At a
glance
• Continuing
credit worries in the US financial sector has seen the demise of
investment bank Lehman Brothers, with others teetering
• Australian
financial sector caught in market turmoil, but Australian banks are
better regulated and are far less exposed to poor mortgage loans
and credit worries
• Value
is emerging, even if we’re not yet at the bottom
The
latest shoe to fall is the bankruptcy of Lehman Brothers, an
institution with 158 years of history behind it. Perhaps as damning
for markets as the bankruptcy itself was the fact that the Fed/US
Treasury was ultimately not prepared to stop it from happening.
This raised fears that the dominoes may keep falling, but it could
also be interpreted as expressing the view that the official family
– the Fed/US Treasury – is (relatively) optimistic about the
ability of the financial system ultimately to stabilize of its own
accord.
Who
falls next?
Of
course, it isn’t only Lehman Brothers. Merrill Lynch, a relatively
sprightly 94-year-old, has fallen into the arms of the Bank of
America. AIG, a large insurance company was also in trouble until
the US Fed agreed to provide up to $US85 billion ($107 billion) in
an emergency, two-year loan. Washington Mutual, the US’s largest
savings and loan association, is also teetering.
The
Fed reacted with yet another ‘Sunday evening rescue package’, which
apparently convinced no-one of its efficacy. On Monday, the Dow
fell by more than 500 points, or 4.4%. The points fall is the
sixth-largest ever. How many more dominoes are there to fall (all
of the likely candidates seem to have been identified, so there is
a lot of bad news already priced in), and what if the
financial-sector turmoil weakens the economy significantly
further?
The
latter is to me the more important; while it is my view that the US
has been in (mild) recession for some time, so far the Wall Street
issues have had remarkably little effect on life in middle America.
Figuring out what financial disturbances do to the real economy is
a very inexact science. Witness, for example, how well the real
economy stood up in the aftermath of the 1987 crash.
What
does this mean for Australian investors?
The
obvious question to ask is: what are the flow-on effects likely to
be for the Australian market? In particular, to what extent are our
banks exposed to the same sort of issues that have plagued
financial institutions in the US? While I am no expert, my reading
is that the Australian banks are better regulated and are far less
exposed to poor mortgage loans and to leverage issues.
Nevertheless, our financial sector has been caught in the
downdraft. All of the major banks were down at market close on
Tuesday (17 Sept) but the perceived leverage players, Macquarie and
Babcock and Brown, for example, are down by much more.
Buy,
hold or sell?
Many
seasoned market practitioners make the point that the bottom isn’t
in sight until investors give up, and fear moves from the dominant
emotion to become the only emotion. My reading is that we are close
to that point, if we are not already there. One of the Rothschilds
apparently said many years ago that the best time to buy was when
there was blood in the streets, even if it was your blood. While it
is clear that things can get worse before they get better, there is
a lot of good value out there, measured by company price to
earnings ratios, for example. Any decision to sell now requires a
later decision to re-enter the market.
Every
cloud, they say, has a silver lining. The data relating to the
Australian economy has been surprisingly good lately, and it is
likely that the Reserve Bank had talked itself out of a further cut
in the cash rate in October, while not ruling out eventually lower
rates. While the October meeting is still three weeks away, this
latest outbreak of market weakness has unquestionably increased the
chance of a further near-term cut in rates.
Chris
Caton
BT Chief Economist
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23 September
2008 Back
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