Summary:
Economists warns that a lengthy period of gloom in store for the stockmarkets: almost everything that could go wrong is going wrong for world stock markets: falling profits, slowing economic growth, rising inflation and interest rates. All made worse by the credit crunch. Problem for financial markets is that the virtuous circle which pushed asset prices higher (lending on housing collateral) in the middle of this decade is turning vicious. Investors might have coped with the credit crunch if it were not for the high commodity prices, and vice versa, and do not know whether to fear inflation or recession more, but they know that both at once are unpleasant. Best investors can do is hope that something will turn up (e.g. collapse in oil prices). (Published: 03/07/08)
Notes:
- June 2008: US stockmarket had its worst month since 2002
- down >20% from peak
- definition of bear market
- global stockmarkets fell by $3tr
- 10% decline in emerging markets
- Four forces impel stockmarkets
- economic growth: slowing
- profits growth: slowing
- interest rates: rising
- inflation: rising
- soaring oil and food prices
- high commodity prices
- have acted as a terms-of-trade shock for consuming countries
- the things they buy from abroad cost more compared with the the things they export
- has made them poorer
- questions
- will workers suffer by seeing their wages rise more slowly than inflation?
- will companies have to compensate their workers by raising wages, sacrificing their profit margings?
- will central banks treat high commodity prices as a blip, and leave interest rates low, penalising savers?
- will they raise interest rates and riks pushing the economy into recession?
- all made worse by the credit crunch
- effects can be seen in
- sharp falls in mortgage approvals in both US and Britain
- data produced by the Fed which show that loans made by banks have fallen over the past three months
- thightening in credit has taken long time to show up in the numbers because of the way that banks were operating before the summer of 2007
- had pushed much of their lending business off-balance-sheet
- loans were bought by specialist entities like structured-investment vehicles (SIVs) and conduits
- when the market for subprime loans collapsed, lot of these loans came back on to the banks' balance -sheets
- banks had made back-up commitments to businesses to lend money if needed
- with the collapse in other debt markets (e.g. asset-backed commercial paper), corporate borrowers cashed in those chips
- as a result banks found their loan books expanding
- now banks more careful
- chastened by the huge amounts of capital they have had to raise to strengthen their balance-sheets
- problem for financial markets is that the virtuous circle which pushed asset prices higher in the middle of this decade may be turning vicious
- banks lend money against the collateral of assets
- most notably in the form of housing
- as house prices increase, collateral raises in value and banks are willing to lend more
- enables buyers to bid up prices even further
- when banks stop lending, buyers unable to purchase assets
- some investors forced to sell to pay of loans
- value of collateral fals
- making banks even more reluctant to lend
- markets freeze up, as neither buyers nor sellers have the confidence to do business
- cfr. Finland, Sweden in early 1990s
- house prices fell
- personal-savings rates jumped by 12-14%
- similar move in US or Britain would have a devastating effect on consumer demand, and thus GDP growth over the next couple of years
- as yet, has been more of an effect on consumer sentiment than actual retail sales
- although individual retailers (e.g. M&S) are suffering
- companies: with consumers depressed and banks unwilling to lend, why should they invest?
- market's sorrows have come in batallions, not single spies
- investors might have coped with the credit crunch if it were not for the high commodity prices, and vice versa
- do not know whether to fear inflation or recession more, but they know that both at once are unpleasant
- lengthy period of gloom in store for the stockmarkets
- best investors can do is hope that something will turn up
- e.g. a collapse in oil prices
