With Friday's falls, 2008 is shaping up to be the worst year on record for global stock markets. Last week the FTSE 100 fell 5%, the DAX 4.96% and the CAC 3.54. In the US, the Dow was off 5.35% on the week and the S&P 500 down 6.78%. From its peak on the 9th of October 2007, the S&P 500 has now declined a massive 44%% from its peak on October 9th 2007. There is still some way to go to match with 1931's -62% decline from a peak without a 20% reversal. That said, the current bear market is currently in the top 5 collapses from a peak without a 20% reversal. Bank of England governor Mervyn King grabbed the headlines last week by daring to mention the R word. Friday's dire UK GDP figures were the final nail in the coffin, sparking the flood of selling witnessed at the end of last week. Markets have been pricing in the likelihood of a UK recession for some time, but King's comments and the GDP figures hit home because they imply a deeper and uglier recession than previously feared.
The Dollar reigned supreme last week as the Pound and Euro fell heavily. Although the US economy is also in dire straits, their interest rates have less distance to fall at 1.5% currently. By contrast the UK has a relatively high interest rate at 4.5%, and with a deteriating economic climate, these rates are set to tumble. Interest rates in the Eurozone are currently 3.75% with expectations for further cuts. As expectations for lower interest rates are negative for currencies, last week's dramatic falls imply deep cuts to come from the Bank of England. The last time the Pound fell so much against the Dollar was when the Pound was ejected from the ERM. The recent collapse is eerily similar to the 1992 plunge. Then as now, the pound fell from above $2 to the pound to less than $1.60 in less than three months. The eventual low of that run was 1.4068 in January 1992. If that run is anything to go by, the current run on the pound could have further to go.
Alistair Darling's plan to borrow his way out of trouble, and Sarkozy's left leaning call to support the Eurozone's troubled industries as the US did with their auto manufacturers have put considerable pressure on the Pound and Euro. Barclay's announcement that it is planning the first government guaranteed bond sale has also added to the list of potential liabilities facing UK plc. The prospects of growth for the financial sector also hit sentiment last week. Large US companies disappointed with their earnings announcements, and investors priced in the worst quarterly cut in dividends since 1944. The majority of these cuts are in the financial sector.
This weeks economic announcements are dominated by the FOMC interest rate decision on Wednesday. Federal fund futures are currently implying a 45% chance of a cut down to 1%. This seems the most likely outcome for this weeks meeting though a cut down to 0.75% cannot be ruled out and the futures market is currently implying a 30% chance of this happening.
One positive from last week, was that the credit markets are showing increasing signs of improvement with overnight Libor looking more like overnight Libor. Even three month Libor has continued to improve. The coordinated moves from central governments seem to have hit their mark, although it all came too late for the wider economy. Financial markets are already starting to discount a deep recession. Oil prices coming off the boil will help embattled consumers, but oil stocks contributed significantly to the FTSE's positive performance in the last three years, not to mention the extra tax revenue for the treasury.
With UK banks forced to cut their dividend growth, and warnings from some commentators such as Tassim Taleb, that banks will now become more like utilities than engines of financial speculation, growth in the financial sector may never again reach the heights achieved in the last two decades. With the FTSE's two major sectors in reverse, the prospects of a meaningful recovery for the FTSE look remote. A One Touch trade predicting that the FTSE 100 will touch 3100 at any time during the next 6 months could return 50% at BetOnMarkets.
