Yesterday wasn’t just dangerous. It was destructive. Yesterday alone Aussie investors lost $110 billion in the biggest one-day drop since 1989, and the fourth-largest in history. In the last twelve days the market has lost 18%, and 25% since the highs in November.
The intra-day reversal we were looking for seemed like it was coming right on time around noon yesterday. But as markets in Asia opened, they plunged. And as trading screens everywhere filled with shocking numbers from Bombay, Hong Kong, and Tokyo, the ASX/200 closed on its lows, down nearly 400 points and seven percent while the All Ords shed 408 points and 7.3%.
It will pay to be a bargain hunter, we reckon. But having a steady hand is hard in times like this. Here’s a recommendation, after reading today’s Markets and Money, turn your computer off and go for a nice long walk. Don’t keep refreshing the screen. It will give you high blood pressure. We know from experience. Back to the markets…
Overnight, Ben Bernanke did almost exactly what we predicted he would. For the first time since the end of 2001, the Fed cut rates between meetings. It was not the full 100 basis point “super cut” in the Funds rate. But by a vote of 8-1, the Open Market committee slashed seventy five basis points off short-term lending rates, saying the risks to growth were “appreciable.”
The risks are more than appreciable. They are a clear and present danger to share prices. But Team Bernanke had little choice. Central banking is besieged. On the one flank, the contracting credit bubble deflates stock and property prices. On the other flank, inflation puts the torch to real things. The lines of retreat are now all but cut off. So where will Bernanke make his last stand? More on that in a moment.
The futures on the S&P ASX/200 indicate the market will rise by at least 200 points at the open. After that, it will be an interesting contest. If the order books are packed with sell orders and more local investors get margin calls, the Fed’s rate cute may just be a rear guard action in a long retreat to new lows.
In America, the markets offer a few clues. The Dow dropped 465 points at the open, but has clawed back most of the loss as we write. This is the sort of action we expected yesterday.
Let’s be clear though. The bear is on the loose in the credit markets, and he has bloodlust. That is not bullish for most Aussie shares prices. Bond insurer AMBAC has lost its triple-A credit rating from ratings agency Fitch. Analysts at National Australia Bank reported yesterday that AMBAC guarantees at least $20 billion in Australian corporate debt.
Bloomberg reports that, “About A$2.2 billion of AMBACc-insured bonds sold by a unit of SP AusNet, an Australian electricity distributor, and Sydney Airport Finance Company Ltd. were this week stripped of their AAA ratings by Fitch Ratings, which lowered Ambac two levels to AA on Jan. 18.” If S&P and Moody’s follow Fitch’s lead and strip AMBAC of its triple-A rating, expect more aftershocks.
So you see, the deleveraging of the world’s financial system is not over. Citigroup cut its growth forecast for US GDP in half, from 2.4% to 1.2%. Bank of America told investors its fourth quarter profit fell by 95%. And rather than soothing badly frayed nerves, the Fed’s rate cut has ignited speculation there may be more corporate defaults ahead.
“The risk of companies defaulting soared on concern that today’s emergency interest rate cut by the Federal Reserve will fail to halt a global economic slowdown, credit-default swaps show,” writes Shannon Herrington at Bloomberg. “Benchmark gauges of corporate default risk in the U.S. and Europe climbed to the highest since they were created in 2004.”
It is getting harder to buy risk insurance. Even easy money from the Fed is not trusted. But Bernanke had to do something, didn’t he? An inter-meeting rate move makes the Fed look like it is behind the arc of events. And it is. But we believe that while the credit and financial markets will remain in turmoil, there will be at least one clear reaction: a weaker U.S. dollar.
After the Fed’s decision to lower rates, the greenback declined against 14 of the 16 currencies against which it measured. The growing rate differential with the kiwi and Aussie dollars sparked a 2.7% rally in the kiwi and a one percent gain in the Aussie. So what is next?
This is uncharted financial territory, but we will give you our best guess: more deflating financial assets and inflation in real goods. The Australian Bureau of Statistics releases consumer price inflation data this morning. They should show that prices are rising for real things.
This vicious deflation in financial assets coupled with rising prices for real things puts Aussie resource stocks in a strange crossfire. Do they rise because the U.S. dollar is weaker and consumer prices are going up along with commodities? Or do they fall because they are stocks?
Gold was up $9 in New York trading. But oil fell. That gives us a clue. But on the stock market, both gold and oil stocks traded lower. Does the data support a conclusion? Should you just stay in cash? Load up on bargains?
These are all questions you should discuss with your financial advisor. And if he didn’t show up for work today, it’s time to find a new one. We’ll tell you what we think though: the world has seen a series of increasingly large bubbles since 1998, in emerging markets, the Tech Bubble, housing markets in the U.S., U.K., and probably here in Australia.
The bubble that’s deflating now—the credit bubble—was the biggest of them all. It was global, complex, and ended up affecting everyone from individual households to global investment banks. The Fed has only one more bubble to blow: tangible goods, and especially precious metals.
History shows that monetary policy—making credit available cheaply—is a blunt tool at best. You can make it easier for people to borrow. But you can’t control what they do with the money once they borrow it. You have no idea where it will go.
Will investors hoard cash? Will debtors use new lines of credit to pay off old creditors? Will a new speculative bubble be kicked off in a new class of exotic financial instruments? We can’t say for sure. But we suspect the answer to all those is, “No”.
There is one last bubble to be blown. As the Fed makes its last stand against the relentless forces of credit contraction and rising real prices, we think investors will flee for the only thing that seems solid, real, and steady in the world of assets. Gold.
It is not a lock that gold shares will follow the metal price higher. That is your risk in the share market these days, that commodity producing stocks behave like stocks and not like the underlying commodities they produce, which should rise as the U.S. dollar weakens.
There are many more aspects to the unfolding story, of course. But the rise of epic inflation is upon us. Stay tuned.
Markets and Money