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Investment
Quarterly - Q4 07:
Fourth Quarter 07 market overview |
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US sub-prime mortgage debacle dominated the third quarter
of 2007 and the resulting volatility is likely to be with
us for some time. As such, says Heather Lamont, it is especially
important to concentrate on the longer-term |
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The
third quarter of 2007 was characterised by weakness and volatility.
Although issues in the US sub-prime mortgage market had been
influential factors for some time, the deepening of these
problems impacted financial markets across the board.
Concerns about the extent of banks’ exposure to sub-prime
securities led to liquidity across global financial markets
quickly evaporating, necessitating intervention from central
banks. Against this background, the support to equity markets
of mergers and acquisitions quickly faded and the bid premiums
that had been built into many share prices were quickly lost.
US housing market problems also raised concerns that the wider
US and global economies could be under threat and accordingly
equity markets experienced sharp bouts of weakness as risk
aversion increased, leading many investors to seek the safety
of bonds and cash.
While these global economic concerns dominated, generally
sound earnings and attractive equity valuations went largely
unnoticed.
In the UK, the Bank of England raised interest rates by 0.25%
to 5.75% in July, but rates were held thereafter as a result
of moderating inflation and global economic concerns. Financial
and real estate related sectors in the UK were among the leading
decliners amid fears about sub-prime losses and the potential
for the UK property market to fall.
Northern Rock was the largest casualty of the contraction
in credit markets as the mortgage bank was forced to request
emergency funding from the Bank of England. The collapse in
the group’s share price dragged down other UK focused
mortgage banks and both Alliance & Leicester and Bradford
& Bingley were highly volatile.
European equities proved more resilient than their UK peers,
but were still subdued as the supports of reasonable valuations
and earnings momentum were largely negated by global economic
concerns. Europe’s major investment banks were under
pressure as news slowly emerged about their exposure to US
sub-prime securities and, again, real estate groups and house
builders were negatively impacted. Although the economy remained
firm, the European Central Bank held interest rates at 4%,
with the increased uncertainty about the global economic outlook
a contributory factor.
Early in July, US stocks hit record highs and the Dow Jones
Industrial Average broke through the 14,000 level for the
first time. However, deepening problems in the housing market
and signs that they may be spreading to other parts of the
economy prompted stocks to quickly fall back. Weaker than
expected employment data raised concerns about the outlook
for the US economy and highlighted its vulnerability to further
housing market difficulties.
Expectations for an interest rate cut from the Federal Reserve
quickly increased and benign inflation data added to the pressure
on policymakers to ease monetary policy. The Federal Reserve
reduced interest rates by 0.5% at their September meeting,
taking the prevailing rate to 4.75%. The extent of the cut
took financial markets by surprise and the Dow Jones recorded
its best one day performance in four years on the back of
the news. Expectations for further rate cuts supported equities
at the end of the period and saw US stocks once again approach
record levels.
The inconsistent nature of economic data in Japan was matched
by generally mixed corporate results and the combination of
these factors weighed on Japanese stocks. Other Asian markets
again provided the outstanding performance during the third
quarter, with China the main driver as the pace of economic
growth remained high and despite measures from the Chinese
authorities to attempt to moderate future growth.
Government intervention did little to cool investor enthusiasm
for Chinese equities and other markets in the region benefited
from similarly positive sentiment. Equities in Hong Kong,
Korea and Mumbai were among those to hit record highs and
the region as a whole remained largely untroubled by the potential
slowdown in the US.
The current environment is undoubtedly a challenging one for
financial markets, with the full impact of the sub-prime crisis
yet to be revealed. In our view, equity market valuations
are reasonable, with the current turbulence in markets offering
long-term opportunities.
However, volatility is likely to be with us for some time
and so we believe that it is important to concentrate on the
longer-term picture.
Heather Lamont is head of charity business at HSBC
Investments
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