“Fear is gripping investors and the bears are roaring,” says James Ashton in The Sunday Times. Mounting uncertainty over banks’ exposure to subprime mortgage assets knocked over 3% off US, UK and European stocks last week. Following news of thumping subprime-related write-downs at Merrill Lynch and Citigroup, Morgan Stanley revealed a $3.7bn write-off and Wachovia Securities, America’s fourth-largest bank, warned of $1.1bn of losses in October alone.
In Britain, concern that Barclays could face a hefty write-off sent its shares into a tailspin, with trading seizing up last Friday as the stock exchange was overwhelmed with sellers heading for the exit. Royal Bank of Scotland shares have also fallen by about 20% in the past month.
“We’re not out of the woods yet,” as one analyst puts it with some understatement. The US housing market continues to deteriorate and defaults will keep climbing as low initial interest rates on adjustable mortgages expire, while ratings agencies will downgrade hundreds of mortgage-related investments valued at tens of billions of dollars as the malaise worsens, says The Wall Street Journal. Deutsche Bank’s Mike Mayo reckons subprime-related losses could reach $300bn-$400bn worldwide (with Barclays, RBS and HSBC writing off around $5bn each). And with subprime-linked derivatives spread around the world, nobody knows quite where the losses will emerge.
In addition, concern over the credit squeeze’s impact on the economy has spread. A US index of large technology stocks has posted its worst week in five years after networking equipment giant Cisco highlighted slowing demand for equipment from banks and car firms, raising fears of a corporate spending slowdown.
Business spending was hardly booming when corporate profit growth and household demand were strong, says Paul Kasriel of Northern Trust. So why expect it to keep growing now that they are weakening?
Speaking of which, the 1.6% rise in US underlying retail sales last month was the weakest October result since 1995, while the steep slide in consumer confidence over the past three months, equalled only in the past two recessions, bodes ill, says David Rosenberg of Merrill Lynch.
With overindebted consumers now beset by an oil-price spike as well as a sliding housing market, US GDP may well shrink this quarter, says Capital Economics.
And it “increasingly looks like contagion is beginning to prevail over decoupling”, says Ian Campbell on Breakingviews. In October, a global manufacturing output index revealed the weakest rate of growth in four years, with output sliding in the US and the UK and eurozone readings down sharply.
With Europe and Japan weakening, investors are becoming increasingly concerned about global growth, says Ethan Harris of Lehman Brothers. “There are more countries in the caboose now than the engine.” Recent slides in emerging markets also point to “a palpable sense of deepening gloom over the world’s economic prospects”, as John Authers puts it in the FT.
Against this backdrop, it’s interesting to note that Teun Draaisma of Morgan Stanley, who presciently advised selling in June and buying in mid-August, has changed his tune. He has so far foreseen a major market upswing akin to the tech craze after the LTCM jitters subsided in 1998. But now he’s taking profits. Morgan Stanley no longer wants to bet against the deepening credit crunch causing a US recession, given that overextended consumers are vulnerable to sliding house prices and tightening credit conditions. And “we wouldn’t count on” the rest of the world decoupling from a sharp US slowdown.
The world is still “dangerously dependent on credit-fuelled spending in the US”, says Roger Bootle. But with commodity prices stoking inflation, central banks can’t slash rates to boost economies. “The cavalry isn’t coming to save us from this slowdown.” The years of easy money are over.