Equity markets’ strong rebound of the past few days lost momentum early this week as risk aversion returned.
Markets may be realising that “none of the horrors” that have sent stocks reeling have vanished, says Alan Abelson in Barron’s. “Just the opposite,” in fact.
The credit crisis has “settled in for the holidays”, says Ashley Seager in The Guardian. The one-month sterling interbank rate rose to a nine-year high of 6.7% on Monday, mirroring recent sharp spikes in the one-month euro and dollar rates. The benchmark three-month contract, on which most interest rates throughout the UK are based, is at a two-month high.
The higher one-month interbank rate is partly due to the fact that banks are hoarding cash to tide them over the Christmas period when markets are closed. But the crucial issue, says Joachim Fels of Morgan Stanley, is that banks’ balance sheets are under pressure due to subprime writedowns – making them unwilling to lend to each other or to households and firms, which in turn implies slower economic growth.
And the prognosis for banks’ balance sheets is hardly rosy. The tumbling housing market implies further mortgage defaults ahead, while credit card and auto loans “are all seeing a serious rise in delinquencies”, says John Mauldin on Investorsinsight.com.
With overindebted consumers also feeling the pinch from high oil prices and falling employment – real consumer spending contracted marginally in October – the overall economic outlook is darkening rapidly. The list of analysts who think a recession is imminent, or already under way, is growing.
Lower interest rates are unlikely to help matters much. “When banks stop wanting to lend, a half percent here or there on or off rates becomes irrelevant,” says William Kay in The Sunday Times. The three-month dollar interbank rate has gone up since the last rate cut in the US, says David Rosenberg of Merrill Lynch; the “arteries in the credit market and banking system” have not been unclogged. History shows that when an asset and credit bubble begins to unwind, the deleveraging process tends to play out, despite the Fed’s best efforts; attempts to steer the economy with interest rates are akin to “pushing on a string”.
Stocks are below their levels of mid-September, when the Fed began to cut rates, and investors should also note that whenever the Fed has had to cut by more than 0.75% – the tally so far – there has been a hard landing for the economy rather than a short dip. And “every recession in history was associated with a bear market in stocks”. So “the last thing” investors should be looking forward to is another rate cut.
An earnings collapse “beats low interest rates every time”, adds Jon Markman on MSN Money. And the earnings recession has arrived: operating earnings for the S&P 500 slid by 8.5% year-on-year in the third quarter, marking the first slide since the tail end of the last recession in 2001.
“The domestic profits squeeze is in its early stages and will be severe enough to overwhelm strong foreign earnings,” says Joseph Quinlan of Bank of America Corp. Weaker earnings in turn generate lower business spending and hiring, increasing downward pressure on growth.
UK stocks are also looking increasingly vulnerable. UK strategist Morgan Stanley’s Graham Secker “would not be surprised to see earnings contract” over the next 12 months as the financial crisis dents the US, UK and global growth.
There is a 35% chance of an economic and profits recession that could lower the FTSE to 5,350 by the end of 2008 from around 6,300 today, he reckons. Investors are in for a rocky ride, says Investec’s Roger Cursley. The traditional December rally may already be over.