So Where Now To For Markets?

So Where Now To For Markets?
July 23 2007 - Australasian Investment Review – (AIR)

Another week and another strong performance for the Australian dollar and Australian stocks, with world metal prices up on Friday.

The US market was sold off heavily on Friday on growing worries about the subprime mortgage crisis and the growing credit crunch.

The Dow fell 149 points and the S&P 500 and Nasdaq were all weak.

The Aussie finished the week above 88 USc for the first time in 18 years, copper prices finished above $US8,000 a tonne for the first time in more than a year, lead and tin prices hit new records late in the week, gold rose and oil was steady to slightly down.

The Aussie ended at 88.02USc in New York early Saturday morning, Australian time.
But US bond rates again fell sharply, closing at 4.95% for the bellwether 10-year bond as nervous investors sought the safety of the safest securities in the market: US government bonds.

There was also a rush into German and UK Government bonds and out of shares and derivatives as well.

Here today it will be a battle between the optimists about metal prices and growth (China’s third rate rise of the year will help their case). The Share Price Index was pointing at a 42 point fall at the opening today.

On Friday, the local market closed the week in record territory thanks to stronger metal prices helping BHP, Rio and other resource groups.

The ASX200 index closed at a record 6421.8, compared to its previous best just two weeks ago of 6400.6 and the broader All Ordinaries also ended on a new high of 6456.7, ahead of its previous record of 6429.5 a fortnight earlier.

In New York, the Dow fell 149.33 points to 13,851.08; the S&P 500 lost 18.98 points to finish at 1,534.10 and the Nasdaq dropped 32.44 points to end at 2,687.60.

The Dow ended the week down 0.4 per cent, the S&P fell 1.2 per cent, and the Nasdaq fell 0.7 per cent in what was the first losing week for a month.

The impact of the lightening liquidly can be seen from figures for high-yield or low-quality credit.

Demand from investors has all but dried up and new issues of such debt again under the $US 1 billion level for the third week in a row. Thomson Financial said there had been $9.7 billion of high-yield issues in Europe in the last week of June, last week it had fallen to just $US322 million.

One private equity deal being closely watched is the multi-billion dollar refinancing of the Alliance Boots buyout in Britain by KKR that was supposed to have been completed last Friday.
But investors baulked at the terms during the week and demanded tougher conditions and higher yields, forcing KKR and its advisers to shape the offering.

The rise in US Treasury bonds onFriday was back byinvestor worries about losses in securities backed by subprime mortgages: they finallybroke through the optimism about earnings and takeover situations.

Helping that change in sentiment was the first official estimate from Federal Reserve Chairman, Ben Bernanke, who put losses from subprime mortgages and associated securities at between $US50 billion and $US100 billion.

Investors should always understand that the first estimate in a financial crash of this sort is always the best: the losses always worsen.

The coming week will see investor nerves tested by new information on sales of existing homes, the stock of unsold homes and new housing starts, all of which are forecast to worsen (but could actually see a small steadying such has been the rate of decline lately).

The big worry is if the slowdown in housing and the losses start impacting the wider economy: the Fed chairman told congress last week that the problem was spreading and would get worse before it got better.

The US 10-year bond’s price rose sharply, knocking yields down by 0.14 percentage points on Friday to 4.95 per cent.

That took the fall in yield in the last fortnight to 0.235 percentage points, the biggest drop since March 2004.

The move reverses most of the June advance in 10-year yields to a five-year high of 5.32 per cent as investors have reacted to the emerging toll of losses at hedge funds (Bear Stearns, Caliber in London and Basis Capital in Sydney) and ratings cut (a bit belatedly) on securities backed by subprime mortgages by Moody’s Investors Service and Standard & Poor’s.

S&P cut 14 ratings on European collateralized debt obligations late last week after downgrading 75 US CDOs made up of subprime mortgage derivatives on July 19. The European rating actions weren’t related to the US move.
Meanwhile, the AMP’s Dr Shane Oliver points out that the US sub-prime mortgage crisis and the latest spike in oil prices have the potential to create further volatility over the next few months.

He says it’s also worth noting that the August to October period often sees share market corrections, and with corrections over the last few years coming along every 6 to 9 months, one will be due soon.
“However, the broad trend in shares is likely to remain up. Valuations are not excessive, profit growth is likely to remain solid, the broad macro backdrop of reasonable growth and modest inflation is very supportive and interest rates are unlikely to reach threatening levels.
“Overall, the environment is likely to be similar to that in the second half of the 1990s which saw rising volatility, rising credit spreads as corporate debt rose, occasional financial problems, but a still rising trend in share prices.

“With the Australian share market, as measured by the key ASX200, finally decisively breaking through the 6400 level that has provided stiff resistance since early May; a quick run up probably to around the 6600 level is looking likely as shorts will be forced to cover their positions.
“It’s highly doubtful that the recent flood of super inflows has been fully invested and Future Fund assets are also likely to be supportive.

“It’s also worth noting that there is a lot of scepticism and caution around at present regarding the outlook and this is normally good for shares because it means that there is still lots of cash sitting on the sidelines that can come in and push the market higher.
“Bond yields are likely to trade sideways over the next year with the ongoing US housing slump and falling US inflation likely to keep a lid on bond yields and may even drive a fall in the short term.

“While the $A is very expensive on conventional valuation measures the path of least resistance for the $A remain up, at least to the February 1989 high of $US0.8950.
“Commodity prices are still running around levels more consistent with parity to the US dollar the interest rate differential versus the $US is likely to widen and the $US remains under downwards pressure generally.”

……………..And watch the prices of QBE and IAG shares after the second round of flooding in Britain in a month at the weekend.Both have large businesses in the UK, with QBE also prominent in the Lloyds market. IAG bought a major UK car insurer last year.

Reports yesterday say UK insurers are facing claims of up $4.4 billion (around 2 billion pounds) after the floods in central England and Wales.The Association of British Insurers said in a statement that it was more than likely the final cost could top the two billion pound level, after flooding a month ago cost around 1.5 billion pounds, or around $3.3 billion.

Other British insurers have already paid out hundreds of millions of dollars in claims on the earlier floods.Like all disasters the first damages estimates will always be the lowest; the cost will rise and the British floods on the past month could be a ‘major event’ in insurance terms.IAG and QBE have already had to payout the best part of $200 million in Australia from the June flooding and storms in the Hunter and Central Coast areas of NSW.

Copyright Australasian Investment Review.
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