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We’re now officially in correction territory.
The FTSE 100 has fallen by more than 10% from its June peak, the generally accepted definition of a correction. The 232-point collapse on Friday – the worst fall in more than four years – meant that, until this morning, the UK blue-chip index had dropped by 10.3%, to be precise.
So what’s next? Do we see a recovery – or are we going to go all the way from correction to crash?
Despite the FTSE 100’s plunge on Friday, today’s likely to be a bit less ugly. US stocks managed to close flat on Friday, which probably means we’ll see a bit of a rally – or at least, not another 200-point fall today. The index is already about 100 points up as I write this.
Of course, things could easily turn pear-shaped again if another nasty crawls out of the woodwork and Wall Street takes a dive this afternoon.
This is the problem. We’re still at the stage where anything can happen – and markets really don’t like that kind of uncertainty. There are rumours flying about all over the place – Goldman Sachs’s $9bn Global Alpha fund is suspected to have lost out heavily for example. Everyone’s waiting to see where else some nasty sub-prime toxic waste might have washed up, far from the US market where it all began.
So is anywhere safe? Well, let’s just take a moment to remind ourselves of the nature of previous bubbles.
A bubble often accompanies ‘disruptive’ technology. From railroads to the internet, when investors see a hot new technology, they have a tendency to pile in with their eyes shut. This bubble is no different really – it’s just that this time the disruptive technology is a financial one.
The bubble usually relies on investors getting highly excited about what is in its initial stages, a great idea. As long as they get excited enough, they will then go on to swallow whole-heartedly any ridiculous lie as rational exuberance turns irrational.
So for the internet, for example, the big lie was that “profits don’t matter anymore – just sales. Or maybe even just ‘eyeballs’.” For the credit bubble, the big lie has been – “you can take the risk out of high-risk assets, but keep the juicy yields, just by cleverly packaging up the debt.”
Now when a bubble pops, everyone tends to suffer. People panic. Investors who hold loss-making positions in the bubble assets are forced to liquidate perfectly sound assets to cover their backs. The clear-out hits markets across the board.
But ultimately, it’s the bubble assets that are wiped out, while the decent ones recover. There are plenty of once high-flying dot.com companies that are no longer with us, but ultimately, the old economy stocks which had been neglected turned out to be perfectly good investments, even though they might have taken a hit at the time of the collapse.
It’s the same story now – once the fall-out is over, the main damage will be among those companies most exposed to the credit bubble. The problem is that credit is a much wider-ranging sector than technology. It’s got its tentacles everywhere. The world has never been more leveraged, nor have lending standards ever been lower or more careless – which makes sell-offs all the more violent.
As The Sunday Telegraph pointed out, it seems that Friday’s FTSE 100 plunge was partly caused by banks tightening up their margin requirements and demanding more money from hedge funds who had borrowed to invest. The dive was partly down to stocks being sold to cover these margin calls.
But in the end, the companies that benefited little from the credit boom should be the ones to recover best from this latest pile-up. It’s not hard to find these companies – by and large, they’re the ones that analysts have been criticising for the past few years as being underleveraged. The ones who the City has been calling on to restructure their balance sheets. The ones that have been too big to be pushed into financial engineering by private equity predators.
Thankfully for panicked investors, these are also among the safest stocks on the market. We’re talking the biggest FTSE 100 stocks here – companies like BP, Shell, and GlaxoSmithKline. Solid dividend payers on low (sometimes single-digit) p/e ratios – which have only got even lower since the latest turmoil hit the markets.
So when should you buy in? Well, economist and stockbroker James Ferguson has some very strong views on this – if you’d like to read his take on when to go bargain-hunting, you can find it in our latest issue: Latest issue.
(If you’re not already a subscriber, you can sign up for a three-week free trial by clicking here: Sign up for a three-week free trial of MoneyWeek.)
And if you like what you read, remember James also runs his own investment email: Model Investor.
Turning to the wider markets…
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In London, the FTSE 100 tumbled 232 points to close at 6,038 on Friday, a fall of nearly 4%. Financials led the blue-chips lower, with asset managers Man Group and Schroders suffering some of the day’s heaviest losses. And Barclays fell on rumours that it is to walk away from its takeover bid for ABN Amro. For a full market report, see: London market close.
On the Continent, the major indices also closed substantially lower. In Paris, the CAC-40 was 176 points lower, at 5,448, with financials including BNP Paribas and Societe Generale bearing the brunt of losses. The Frankfurt DAX-30 was 110 points lower, at 7,343.
On Wall Street, US stocks clawed back most of the morning’s heavy losses on Friday afternoon after the Federal Reserve intervened in the credit markets with the biggest injection of cash since the September 11 terrorist attacks. The Dow Jones closed 31 points lower, at 13,239, having dipped as low as 13,057 in intra-day trading. The tech-heavy Nasdaq was down 11 points, at 2,544. And the S&P 500 was a fraction of a point lower, at 1,453.
Asian markets took their lead from the late recovery on Wall Street and rebounded from recent losses today. The Nikkei was up 35 points to 16,800 and the Hang Seng was up 115 points to 21,908.
Crude oil had risen 50c to $71.97 this morning. And Brent spot was at $70.16.
Spot gold hit a low of $658.10 on Friday but had climbed back to $672.30 this morning on safe-haven buying. Silver tracked gold to a five-week low of $12.57 on Friday but had risen to $12.80 this morning.
In the foreign exchange market, sterling had fallen against the dollar, euro and the yen this morning as investors spurned high-yielding currencies. The pound was last trading at 2.0179 against the dollar, 1.4762 against the euro and 238.63 against the Japanese yen. And the dollar was at 0.7313 against the euro and 118.24 against the yen.
And in Europe this morning, markets were on the up again. At the time of writing, the FTSE 100 had risen 118 points to 6,156, the Paris CAC-40 had risen by as much as 69 points to 5,518 and the DAX-30 was up by as much as 79 points, at 7,422. For up-do-date markets news throughout the day, see: MoneyWeek news.
And our two recommended articles for today…
Which direction will financials come under attack from next?
– It looks as though the credit market malaise is still in its infancy, says Jeremy Batstone-Carr. There is little doubt that more banks will suffer – but could the crisis prompt a full-blown recession? And should you be avoiding equities altogether right now? For more analysis of the situation financial markets now find themselves in, click here: Which direction will financials come under attack from next?
Is Britain about to slide down the subprime slope?
– BNP Paribas, IKB, NIBC… Investment banks on this side of the Atlantic are feeling the pain as US subprime losses spill over into Europe. But whilst attention may have been focused on the effects of the cooling US housing market, don’t forget that the UK property market is also heading for trouble. To find out why the situation is likely to get much worse for borrowers with bad debts, read: Is Britain about to slide down the subprime slope?