The Short view: Crisis widens
By John Authers, Investment Editor
Published: November 7 2007 20:29 | Last updated: November 7 2007 22:51
After a horrible afternoon on Wall Street, it is time to look up some definitions. A “correction” occurs when a market falls 10 per cent. The S&P Financials index did that in the last week alone. A “bear market” starts once an index falls 20 per cent; and the S&P financials index has done that since February.
So the US financial sector is now officially in a bear market. This coheres with the credit, where traders have sharply priced up the chances of defaults by big banks.
Share prices are at levels that only make sense if the market has no faith in the valuations on US banks’ balance sheets. Ambac, a big credit insurer, is trading at less than half its book value. The banking sector is trading at its lowest multiple to book for more than a decade.
But the problem is limited to financials. The broader S&P 500 is down only 5.7 per cent from its peak. It is up 4 per cent for the year; the Nasdaq is up 14 per cent. Apart from financials, and the consumer discretionary sector, which includes homebuilders, all the S&P’s sectors are up for the year.
Financials are central to the economy. A true credit crunch, implicit in current prices, would mean a slowdown for everyone. So how can the banks’ bear market be reconciled with bullishness elsewhere?
There are ways to bridge the gap. High oil prices are a boon for energy stocks. The falling dollar buoys exporters, and allays fears of a slowdown. The credit squeeze did not hurt earnings in the third quarter: outside of homebuilders and financials, earnings rose more than 10 per cent. And the fears of writedowns may be overdone.
But this does not close the gap. In the third quarter, the credit squeeze was limited to the financial sector. But what is happening now plainly suggests that for the fourth quarter, companies will have to grapple with a tighter supply of credit.
The S&P may not be facing a bear market. But a correction - which needs a further fall of 4.5 per cent - might be helpful. |
