Careful there! Tread quietly! We are now in official bear territory. Who knows what dangers lurk in these woods?
Yes, the FTSE finally succumbed to the inevitable and crashed through the technical bear barrier this week, following the S&P 500’s ignominious tumble into the badlands earlier this month. On Tuesday the FTSE All-Share fell 20% off its October high of 3,467, whilst this morning the FTSE 100 ventured into bear territory by crashing to 5,333.9, well below the 5,385 bear threshold.
“The news that we have officially entered a bear market comes as no surprise to many investors whose shareholdings have halved in value,” said Angus Campbell, head of sales at Capital Spreads, on Tuesday. “The 20% rule simply confirms what we have long suspected since the beginning of the year – we are well and truly in the grip of a grizzly bear market.”
Manoj Ladwa, a senior trader from TradIndex, said that financial stocks, including RBS and HBOS, had fallen further in response to losses in New York, while house-builders had had another bad morning following a predictably weak trading update from Persimmon. “Mining stocks, which have been a mainstay of the index this year, started to weaken, as analysts lose faith in BHP Billiton’s takeover of Rio Tinto happening any time soon.”
Danger – loose bears
Campbell said that it is a clear danger signal when there is a 100 point rally in a market that is trending lower, followed by a large sell-off to test new lows. “That is exactly what we have seen [this week] with financial stocks yet again leading the way. The outlook for pretty much every stock though is truly dire at the moment and if it was not for the energy and mining sectors keeping us afloat, we would have been testing the 5,000 level months ago.”
He added that if investors now pull out of the energy and mining sectors, it is anyone’s guess where global indices will bottom out. The FTSE 100 currently contains 10 mining companies, and seven oil and gas companies. By market cap, there are four mining, and three oil and gas stocks in the top 10 alone, and these companies collectively account for 50% of the FTSE 100’s total market cap. This is creating some concern amongst the trackers, which are now heavily exposed to what tend to be very cyclical industries.
Meanwhile, the outlook for financials worsens day by day. As the economy grinds to a halt, credit defaults are finally starting to come through, threatening to turn what was a liquidity crisis into a solvency crisis – witness Bradford & Bingley’s increasingly desperate attempts to raise cash. All those blank cheques written by merry banks in the consumer spending boom are now falling due. The UK banks are staring into a black hole of buy-to-let mortgages and worthless credit card debt.
This is reflected starkly by the sector’s performance since the credit crunch began. According to Bert Veldman, senior investment manager, global equity, at ING Investment Management, share prices of financials have dropped by an average of 43 percent since the peak in April 2007. And in the second quarter, global financial equities fell by an average of 12 percent.
Eaten by bears
House-builders are also feeling the pinch, with Capital Economics now predicting a 15 percent fall in UK house prices this year, and a fall of 35 percent over three years. Not surprisingly, house-builders have received a thorough mauling by the bears and are desperately trying to raise capital.
Back at sub-prime’s ground zero, the investment banks are still announcing new write-downs following the long-anticipated monolines downgrades last month. After many warnings, Moody’s finally downgraded Ambac and MBIA – the former by three notches and the latter by five notches. S&P had already downgraded both, suggesting that we will see further fire sales by those investors and conduits who can only hold Triple A-rated securities. Investment banks must also increase their risk-weighted capital to offset these downgrades.
For example, Merrill Lynch holds some $18 billion in collateralised debt obligations and asset-backed securities, of which the majority is insured via monolines. Now that these insurers have been downgraded, the risk for Merrill Lynch has increased. The worry is that this will lead to fresh, substantial write-offs and that banks will be forced to liquidate positions, says Caspar van Grafhorst, head of investment grade credits at ING Investment Management. The market is expecting Merrill to write off about $5 billion for the second quarter.
But Guy de Blonay, manager of the New Star Global Financials Fund, says that the key issue for investment banks is not necessarily whether more write-downs will be revealed but whether they can write new business over the next few years. “There has been a fundamental shift in institutions’ desire to embrace risk. Some profitable business lines may, therefore, be closed for months and perhaps years,” he says.
The worsening economic outlook does not rule out the possibility of bear market rallies, however, and this morning the FTSE 100 obliged with a rebound. This followed reports that the US government was mulling a bail out of its hapless Fannie Mae and Freddie Mac mortgage agencies, which Lehman says will have to write off another $75 billion.
This rally was short-lived, however, as the market then charged headlong into bear territory, perhaps after realising that the fundamentals in the UK hadn’t changed. The question now is whether the combined strength of energy and miners will be able to prevent the FTSE falling further. State Street’s latest fund flows note reported that institutional investors are becoming increasingly sceptical about the commodities boom, with selling already underway in the materials sector.
Bear traps
Joost van Leenders of Fortis Investments points out that bear markets usually end with a final sharp fall as the last bulls capitulate. The average decline during bear markets after recessions is 28 percent, but this includes some very large drops, such as the 50 percent fall after 2001. “These large drops started with overvalued equity markets, which was not the case this time,” he adds. However, earnings have been high, and have only just fallen back to trend. He also believes that economic and profit forecasts for the second half of 2008 look unrealistically high.
Fortis is now adding to Japanese equities – still leading the field as the least loved market around – followed by US and emerging market equities. “We have not suddenly become Japan optimists but we think that a lot of the bad news is priced in,” Leenders says. Certainly the Japanese economy is looking in better shape than the UK’s for once. And those bulls have got to find somewhere else to chew grass, right?
Into The Woods
July 11, 2008 at 1:08 pm (Macroeconomic commentary, UK equity markets) (banks, Bear market, Commodities, energy, financials, Japan equities, mining, monolines, UK equities)
Careful there! Tread quietly! We are now in official bear territory. Who knows what dangers lurk in these woods?
Yes, the FTSE finally succumbed to the inevitable and crashed through the technical bear barrier this week, following the S&P 500’s ignominious tumble into the badlands earlier this month. On Tuesday the FTSE All-Share fell 20% off its October high of 3,467, whilst this morning the FTSE 100 ventured into bear territory by crashing to 5,333.9, well below the 5,385 bear threshold.
“The news that we have officially entered a bear market comes as no surprise to many investors whose shareholdings have halved in value,” said Angus Campbell, head of sales at Capital Spreads, on Tuesday. “The 20% rule simply confirms what we have long suspected since the beginning of the year – we are well and truly in the grip of a grizzly bear market.”
Manoj Ladwa, a senior trader from TradIndex, said that financial stocks, including RBS and HBOS, had fallen further in response to losses in New York, while house-builders had had another bad morning following a predictably weak trading update from Persimmon. “Mining stocks, which have been a mainstay of the index this year, started to weaken, as analysts lose faith in BHP Billiton’s takeover of Rio Tinto happening any time soon.”
Danger – loose bears
Campbell said that it is a clear danger signal when there is a 100 point rally in a market that is trending lower, followed by a large sell-off to test new lows. “That is exactly what we have seen [this week] with financial stocks yet again leading the way. The outlook for pretty much every stock though is truly dire at the moment and if it was not for the energy and mining sectors keeping us afloat, we would have been testing the 5,000 level months ago.”
He added that if investors now pull out of the energy and mining sectors, it is anyone’s guess where global indices will bottom out. The FTSE 100 currently contains 10 mining companies, and seven oil and gas companies. By market cap, there are four mining, and three oil and gas stocks in the top 10 alone, and these companies collectively account for 50% of the FTSE 100’s total market cap. This is creating some concern amongst the trackers, which are now heavily exposed to what tend to be very cyclical industries.
Meanwhile, the outlook for financials worsens day by day. As the economy grinds to a halt, credit defaults are finally starting to come through, threatening to turn what was a liquidity crisis into a solvency crisis – witness Bradford & Bingley’s increasingly desperate attempts to raise cash. All those blank cheques written by merry banks in the consumer spending boom are now falling due. The UK banks are staring into a black hole of buy-to-let mortgages and worthless credit card debt.
This is reflected starkly by the sector’s performance since the credit crunch began. According to Bert Veldman, senior investment manager, global equity, at ING Investment Management, share prices of financials have dropped by an average of 43 percent since the peak in April 2007. And in the second quarter, global financial equities fell by an average of 12 percent.
Eaten by bears
House-builders are also feeling the pinch, with Capital Economics now predicting a 15 percent fall in UK house prices this year, and a fall of 35 percent over three years. Not surprisingly, house-builders have received a thorough mauling by the bears and are desperately trying to raise capital.
Back at sub-prime’s ground zero, the investment banks are still announcing new write-downs following the long-anticipated monolines downgrades last month. After many warnings, Moody’s finally downgraded Ambac and MBIA – the former by three notches and the latter by five notches. S&P had already downgraded both, suggesting that we will see further fire sales by those investors and conduits who can only hold Triple A-rated securities. Investment banks must also increase their risk-weighted capital to offset these downgrades.
For example, Merrill Lynch holds some $18 billion in collateralised debt obligations and asset-backed securities, of which the majority is insured via monolines. Now that these insurers have been downgraded, the risk for Merrill Lynch has increased. The worry is that this will lead to fresh, substantial write-offs and that banks will be forced to liquidate positions, says Caspar van Grafhorst, head of investment grade credits at ING Investment Management. The market is expecting Merrill to write off about $5 billion for the second quarter.
But Guy de Blonay, manager of the New Star Global Financials Fund, says that the key issue for investment banks is not necessarily whether more write-downs will be revealed but whether they can write new business over the next few years. “There has been a fundamental shift in institutions’ desire to embrace risk. Some profitable business lines may, therefore, be closed for months and perhaps years,” he says.
The worsening economic outlook does not rule out the possibility of bear market rallies, however, and this morning the FTSE 100 obliged with a rebound. This followed reports that the US government was mulling a bail out of its hapless Fannie Mae and Freddie Mac mortgage agencies, which Lehman says will have to write off another $75 billion.
This rally was short-lived, however, as the market then charged headlong into bear territory, perhaps after realising that the fundamentals in the UK hadn’t changed. The question now is whether the combined strength of energy and miners will be able to prevent the FTSE falling further. State Street’s latest fund flows note reported that institutional investors are becoming increasingly sceptical about the commodities boom, with selling already underway in the materials sector.
Bear traps
Joost van Leenders of Fortis Investments points out that bear markets usually end with a final sharp fall as the last bulls capitulate. The average decline during bear markets after recessions is 28 percent, but this includes some very large drops, such as the 50 percent fall after 2001. “These large drops started with overvalued equity markets, which was not the case this time,” he adds. However, earnings have been high, and have only just fallen back to trend. He also believes that economic and profit forecasts for the second half of 2008 look unrealistically high.
Fortis is now adding to Japanese equities – still leading the field as the least loved market around – followed by US and emerging market equities. “We have not suddenly become Japan optimists but we think that a lot of the bad news is priced in,” Leenders says. Certainly the Japanese economy is looking in better shape than the UK’s for once. And those bulls have got to find somewhere else to chew grass, right?