Saturday, July 28, 2007

Global overview: Equities tumble on credit woes

Global overview: Equities tumble on credit woes
By Neil Dennis
Copyright The Financial Times Limited 2007
Published: July 27 2007 17:40 | Last updated: July 27 2007 21:29

A sharp sell-off in global equities this week was prompted by persistent concerns over the quality of credit markets and the knock-on effect this was likely to have in funding future takeovers.

The caution prevalent in the market led high volatility to return to equity markets. In London, the FTSE 100 by midday on Friday had swung 120 points either side of its opening level.

Risk aversion hit its highest levels since September 2001 according to the risk index of Swiss investment bank UBS. The VIX index, compiled by the Chicago Board of Options Exchange to measure volatility and investor anxiety, rose to a 13 month high.

Ongoing concerns that sub-prime mortgage losses in the US would spill over into other markets started the rot. On Wednesday, banks helping to finance buy-outs of Chrysler and Alliance Boots postponed the sale of loans on both deals as debt markets turned wary. The equity markets also reacted to the prospect that leveraged buy-outs could dry up.

The global asset allocation team at UBS said such concerns were unjustified and that underlying economic fundamentals – characterised by high levels of profitability and solid, non-inflationary growth in leading economies – did not suggest a backdrop normally associated with financial panic and malaise. Friday’s second-quarter economic growth in the US at an annualised 3.4 per cent was slightly higher than market expectations and remained broadly in line the Federal Reserve’s estimates.

UBS said: “It is impossible to know whether fear will trump fundamentals. Therefore, it is best to stand back and assess market conditions before making portfolio decisions.” The FTSE 100, which on Thursday plunged more than 3 per cent – its worst single session percentage loss since March 2003 – fell 5.6 per cent over the week – its poorest weekly performance since January 2003. In the US, the Dow Jones Industrial Average fell more than 300 points, or 2.3 per cent on Thursday, its worst daily showing since February’s market correction.

Late in New York on Friday, the Dow was down more than 4.2 per cent over the five sessions, its worst weekly performance this year.

Among the emerging markets, Turkey had, until Tuesday, been soaring at record highs after the success of the ruling AK party in the weekend election. The ISE National 100 index subsequently fell 8 per cent over the remainder of the week.

The flight to quality lifted government bond prices, driving yields lower as equities remained on the ropes.

German bunds got an additional lift from a softer-than-expected Ifo business confidence index.

The yield on the 10-year bund fell 11.6 basis points to 4.32 per cent over the week. “The market is very overbought at present but the chances of a significant reversal are relatively limited under the current circumstances,” said Charles Diebel at Nomura.

The yield on the 10-year Treasury note fell 19bp to 4.76 per cent, while the 10-year JGB yield was down 11bp to 1.77 per cent.

Risk aversion in the currency markets ensured that the yen was one of the week’s best performers as investors unwound carry trades, a risky strategy where low yield currencies are sold to fund higher-yielding purchases.

The New Zealand dollar, backed by one of the highest interest rates in the industrial world, fell nearly 5 per cent against the yen this week, in spite of the country’s central bank lifting rates by a further 25 basis points to 8.25 per cent.

Other high yielders also fell sharply. The Australian dollar lost 4.1 per cent and sterling fell 3 per cent.

The yen carry trade shake-out also forced the US dollar higher. It climbed 1.3 per cent over the week against both the euro and the pound, but fell 2 per cent against the yen.

Growing fears that a wider slowdown could dent demand for raw materials hit commodities markets.

Friday’s strong US growth data helped fuel a late rally for oil prices, however. Brent crude bounced back $1.08 cents on the day to close at $76.26 a barrel, just under 0.5 per cent lower over the week.


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