The market’s upswing was interrupted in late October as credit jitters returned. Merrill Lynch reported its first loss in six years thanks to a $7.9bn write-down on securities related to subprime mortgages – only a few weeks after predicting that the hit would be $3.4bn lower. And UBS has now warned of further possible write-downs.
Mounting losses on subprime loans as the housing malaise worsens and downgrades from ratings agencies have begun to undermine even the most highly-rated securities on banks’ books, notes Carrick Mollenkamp in The Wall Street Journal. Last week, for instance, ratings agency Moody’s slashed some tranches of CDOs (pools of mortgage-backed securities with differing risk levels) all the way from the highest rating, Aaa, to junk.
Not only is there scope for more “nasty surprises” on Wall Street, says Thorold Barker in the FT, but “toxic” mortgage products are on financial institutions’ balance-sheets worldwide. Losses may hitherto have been concealed because these insurers or commercial banks may not have to value these assets on a quarterly basis as Wall Street investment banks do. Further downgrades of top-rated tranches will put pressure on these firms to realise losses.
On a wider note, the Bank of England’s Financial Stability report warned last week that tighter credit could spell trouble for the economy, with share prices in the UK and the US looking exposed to further changes in growth estimates. Ted Scott of Foreign & Colonial expects the UK stock market to start focusing on a 2008 earnings slowdown over the next few months as economic problems become more apparent; stocks are vulnerable to another “leg down”.
At present, investors are shrugging off concern over slower growth in the developed world in the belief that “self-sustaining levels of growth” in emerging economies can pick up the slack, as Jeremy Warner points out in The Independent: over half the FTSE 100’s profits come from overseas.
But declaring Brazil, Russia, India and China “the new citadels of the world economy is… premature”, says Michael Sesit on Bloomberg.com. They look too small to provide the necessary power. The Brics’ GDP at the end of 2006 was just 43% of America’s and 56% of the eurozone’s, and developing countries, while trying to boost consumption, remain export-dependent. Most importantly, the decoupling thesis has not yet been tested by a US recession.