Not a day passes without more action and more drama surrounding the biggest financial dislocation in our lifetimes.
What next?
Prime minister Gordon Brown and Chancellor Alistair Darling have fired their £50 billion bazooka to save the 8 biggest UK banks from possible extinction.
In doing so, and in guaranteeing the savings of UK depositors in failed Icelandic bank Icesave, the UK Government has effectively said – “We guarantee all of the savings of UK citizens.”
Close behind, six of the world’s most important central banks, including the US Federal Reserve, the European Central Bank and the Bank of England, announced simultaneous emergency interest rate cuts of half a percentage point.
Here in the UK, that meant the base interest rate falling from 5% to 4.5%.
Wrong Again
In ‘normal’ circumstances, you’d expect stock markets to stabilise at worst, and soar higher at best. You’d be wrong again. The FTSE 100 Index rose briefly into positive territory on the day, before plunging almost 240 points, or 5% to 4367.
US markets tread a similar path, with the Dow Jones posting decent gains at times during the trading day, before headline into its now regular late trading tailspin, closing down 190 points, or 2%, to 9258.
If nothing else, this credit crisis keeps surprising, on the downside, so far.
Fear Still Reigns Supreme
Fear still reigns supreme. But I’d suggest fear is moving from whether the global banking system will fail, to fear about the depth and length of the recession that will inevitably follow.
Banks are still reluctant to lend to each other. But that phase will pass. It might take a few weeks, a few months, maybe even longer, but it will pass. There will still be some casualties, with US Treasury Secretary Henry Paulson saying overnight “One thing we must recognize – even with the new (US) Treasury authorities, some financial institutions will fail.”
Paulson also said “Patience is also needed because the turmoil will not end quickly and significant challenges remain ahead.”
At least he’s being honest.
The Next Phase Of This Bear Market Is Here
The next phase of this debilitating bear market is upon us – fear of recession, and of even depression.
For example…
- How are we all going to pay for all these bank bail-outs? Higher taxes? Lower Government spending on important things like infrastructure, health, defence and education, just to name a few? There are a few years of pain in for most of us.
- China has been the growth engine of the global economy for years now. But confirmation has just come that four key Chinese steel plants have cut production by up to 20% this year. Commodity prices and commodity stocks were hammered yesterday. Is the great commodities boom over?
Has The Commodities Bubble Burst?
On top of the credit crisis induced mass selling and panic on stock markets across the world, we’re now seeing another type of panic and selling, one based more on valuation.
Mining and resources stocks got it in the neck yesterday, with huge companies like Vedanta Resources (LSE: VED), Kazakhmys (LSE: KAZ) and BHP Billiton (LSE: BLT) each plunging more than 10% on the day.
To give you an idea of the state of fear and panic of markets, and about how the market is thinking about commodity prices in the future, you need look no further than the forward price to earnings ratios (P/E) of the three mining companies mentioned above.
| | Market Cap | Share Price | P/E |
|---|
| Vedanta Resources | £24.9 billion | 864p | 5.1 |
| Kazakhmys | £2 billion | 366p | 2.1 |
| BHP Billiton | £21 billion | 971p | 4.6 |
They all look cheap. But are they, given the forthcoming global recession, the slowdown in China, plunging commodity prices, and that in the past, the time to buy miners has been when their P/Es were high, not low?
Can you see the market’s dilemma? Can you see the ordinary investor’s dilemma? Do you buy because they look cheap today? Do you sell because with falling commodity prices, they might look expensive tomorrow?
When you add in the fact that this market is panicky and fearful, you can understand why shares like these lost more than 10% of their value just yesterday.
Heading For More Valuation Pain
Then there’s a company like leading software outfit Autonomy (LSE: AU.). It has cash in the bank, high profit margins and is growing rapidly, but trades on a forward P/E of 22.
Will the forthcoming recession affect its rate of growth and/or its high profit margins? On a P/E of 22, there’s not much margin for error anyway, but in the light of a slowing economy, that risk is multiplied. Yesterday its shares fell 11%. There might be more valuation pain to come even for a quality company like Autonomy.
Should You Sell Now?
So…back to my question at the top of this article – what next?
I’m not sure. Should you sell out before it’s too late? I’m not, but only you can make that decision for yourself.
As everyone is saying, this time it really is different. Unless you are in your nineties, none of us lived through the Great Depression starting 1929 as adults.
This is unchartered territory for all of us.
P.S. The Financial Times is reporting that central banks in Taiwan, South Korea and Hong Kong cut interest rates on Thursday in steps that closely follow America’s and Europe’s policy response to the financial crisis.
P.P.S. In what may be a small piece of positive news for mining and commodity shares, Reuters is reporting overnight that Australia's Prime Minister Kevin Rudd has been assured by China that demand for Australian resources will stay strong.
Rudd said he telephoned Chinese Premier Wen Jiabao on Monday and was told commodity demand would hold up despite China's growth slipping from "11 and 12 percent down to 9 and 10 per cent".
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> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in BHP Billiton.
