The song remains the same - 2008 - Q1 review

By Richard Hunter | 09 Apr, 2008 

Having ended 2007 at a level of 6457, the FTSE100 closed at the end of the first quarter at 5702, a decrease of almost 12%.

It certainly was a start to the year which kept the headline writers busy.

The temporary nationalisation of Northern Rock, the near collapse of Bear Stearns, allegations of rogue trading at SocGen and a major dip in the share price of HBOS following some aggressive short selling all took their due place on the front pages.

Behind these dramas, a more sober story was unfolding.

Just as we had seen in the latter months of 2007, the near perfect storm of the US sub-prime fallout, the ensuing credit squeeze in the money markets, and the general concerns around the US economy in particular weighed heavily on global markets.

The US Federal Reserve acted aggressively on a number of occasions throughout the quarter both in fiscal and monetary terms, not least of which was that US interest rates began 2008 at a level of 4.25% and ended Q1 a full two percentage points lower at 2.25%. In a rather more sedate way, the Monetary Policy Committee reduced rates just once during the quarter to their current level of 5.25%, although many economists expect that the April decision which is due imminently may well carry a further cut.

Meanwhile, the Central Banks around the world have, on a coordinated basis, been attempting to inject liquidity into the markets in an effort to oil the wheels again. To date, this has had limited impact as banks have sought to conserve capital on their balance sheets as opposed to lending it out on the money markets – a move which is beginning to have some effect in the UK as the halcyon days of 125% mortgages and cheap credit are drawing to a close.

Meanwhile, as commodity prices continued their surge and investors flew to safe havens, the oil price comfortably raced past $100 per barrel whilst the gold price peaked at over $1000 per ounce.

From a market perspective, the quarter could be roughly defined in company terms as January being the month for the retailers, February the banks and March a somewhat lacklustre Budget.

The retailers’ comments following Christmas trading were universally cautious for prospects for the rest of the year. Even some of those which had had a successful Christmas made the point that they had needed to begin discounting early, which was all very well for sales volumes but had a negative impact on margins.

The UK banking reporting season in February was accompanied by some chest-thumping as many of the bigger names recorded record profits and increased dividend payouts despite – and maybe even in spite of – the wider market difficulties. The market was only temporarily impressed, as the spectre of the sub-prime fallout was brought back in focus time and time again as the likes of Credit Suisse and UBS announced further painful writedowns.

So, where next for Q2?

The first few days of April certainly showed some promise, with the FTSE100 ending up around 4% on the week. The banking shares showed a somewhat bizarre reaction to the news of more very large UBS and Deutsche Bank writedowns by rising, on average, around 5%. This is not likely to augur a recovery just yet – indeed, some are speculating that the bank shares’ strength has as much to do with bears being forced to cover their short positions as anything else.

In terms of the wider picture, we can expect more volatility and fragility as the global picture continues to unwind. Later in the year, the lagging effects of interest rate cuts may begin to have a beneficial effect on the respective economies, whilst in the US the fiscal stimulus will also take hold later in the year.

A close eye will be kept on any weakening of corporate earnings, whilst the general inflationary picture (oil and food in particular) will warrant further attention.

It always seemed as though the first half of 2008 would be tumultuous and there is little to suggest that this will not indeed play out.

Only the steeliest of traders should even be contemplating trying to double-guess these markets in the short-term. For longer-term investors though, content to see out the current swings, buying into weakness could even provide some opportunities to top up portfolios in the nearer term.