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Market Outlook of the Week(21 – 25 July 2008)
* Tumultuous week - financial markets driven by US banking fear and cheaper oil hopes. As expected, US equities markets have been falling sharply on the recent break below their prior lows and the 200-week moving average. The biggest fundamental driver of those price declines was the fear of more financial institution failures in the US following the collapse of IndyMac and the US Treasury rescue package for Fannie Mae and Freddie Mac. But US equities bounced pm Thursday on a drop in oil prices. However, there was little follow through in Asia, where prices generally continued to weaken. * Risk aversion ups and downs – the inter-market spillovers. Trading broadly in line with US equities, the USD index, DYX, weakened on those renewed concerns over the impact of the housing and credit market crises on US financial institutions and the economy. But it staged a modest rebound later in the week in tandem with that little lift in US equities markets. Gold continued to trade as a “mirror image” of the DXY, pushing higher but correcting slightly on the late week bounce in the USD * Ignore the “noise” – the big picture remains gloomy. The news flow over the course of the week largely confirmed our fears of deepening economic and financial market gloom throughout the world. Bank stocks came under pressure from Japan to Australia for a range of reasons related to the deepening global financial crisis – from exposures to Fannie Mae and Freddie Mac debt amongst Japanese banks to losses from a failed stockbroker in the case of Australia’s ANZ Bank. * US financials – worse is yet to come. We continue to caution that the worst is far from over for US financials, notwithstanding a likely short-term, technical rebound in prices. It is worth noting again that during the Savings & Loans Crisis – which eventually resulted in losses of $153 billion – more than 2000 US financial institutions collapsed. This time around, with potential losses estimated by the IMF at $945 billion and write-offs running at over $400 billion, only six US financial institutions have failed so far. * Inflation grows as an issue across the world even as economies slow. On the economic front, the US data was mixed last week. A significant piece of news was the Fed revising its 2008 GDP forecast higher to 1.0-1.6 per cent, from 0.3-1.2 per cent. But even there, the FOMC acknowledged considerable uncertainty and said risks to their forecasts were skewed to the downside. At the same time, the Fed also revised up its PCE inflation estimate to 3.8-4.2 per cent, from 3.1-3.4 per cent.
* In Australia, the RBA said 12-year high interest rates were already restraining the economy, while inflation should slow “over time.” (Australia’s consumer confidence is now at a 16-year low.) Meanwhile in New Zealand, consumer price rises have continued surging – registering 4 per cent year on year growth – even while the economy has started contracting. In the emerging markets, economic management continued to come under pressure from rising prices – for example, the Bank of Thailand raised rates 25 bps; the Bangko Sentral ng Pilipinas raised rate 50 bps and warned of more hikes to come; and the South Korean government is warning of “micro economic measures” (read price controls) to control prices.
* Expect more equities losses and a bias towards a slightly weaker USD and lower UST yields. Although there had been accelerated stock market declines in recent weeks – and there could be a technical rebound – we expect that selling pressures are far from over. There is likely to be even more bad news ahead on the financial markets. Banks affected by the credit crisis will need more funds, existing shareholders will suffer dilution and it will become increasingly difficult to get investors to take up the offerings except at deep discounts. Although US Treasury yields have bounced around sideways over the past couple of weeks – with a slight upward bias – we expect them to move lower again in coming months. The USD is likely to continue range trading but with a similar slight downward bias.
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