Aug. 17 (Bloomberg) — Stock market investors are starting to price in a global economic slowdown as a financial crisis triggered by U.S. subprime mortgage losses deepens, according to Barclays Capital.
Equity markets are tumbling around the world this week, sending benchmark indexes in Europe and Asia to the lowest levels in months. U.S. stocks fell for most of yesterday before a late rally in banks and securities firms helped restore about $369 billion to the Standard & Poor’s 500 Index and $105 billion to the Dow Jones Industrial Average.
Fund managers and analysts are urging the Federal Reserve to cut interest rates soon to ease the worsening credit crunch caused by losses in the U.S. housing loan market. Countrywide Financial Corp., the biggest U.S. mortgage lender, had to tap an $11.5 billion bank line yesterday. Australia’s Rams Home Loans Group Ltd. failed to refinance A$6.17 billion ($4.8 billion) of short-term U.S. loans, forcing it to seek emergency funding.
Equity markets “are progressively discounting the demise of the heavily levered lenders, whilst starting to assume that there will be a negative impact on the global economic cycle,” London-based Tim Bond, head of asset allocation at Barclays Capital, said in a research note yesterday. “The equity markets appear to be expecting a much worse outcome for credit than the credit markets themselves are discounting.”
Financial stocks in the U.S. and Europe have fallen to almost the same level or below the lowest in the past 15 years relative to earnings, according to the report by the investment banking unit of Barclays Plc, the third-biggest U.K. lender.
Stocks Tumble
Standard & Poor’s 500 Financials Index has lost 8.3 percent since July. Asian stocks tumbled today, with Toyota Motor Corp. poised for its biggest loss in almost four years, after the yen rose to a one-year high as investors fled high-yielding, higher- risk assets on speculation a credit crunch will damp global economic growth.
“If the recent phase of apparent stability in the CDS market is an illusion borne of low liquidity, then the stock market’s attitude towards financial stocks becomes more understandable,” Bond wrote in the report.
Contracts on the CDX North America Investment-Grade Index, a benchmark for the cost of protecting investment-grade bonds, fell 2.5 basis points to 78 basis points after rising as high as 89 basis points earlier yesterday, according to Deutsche Bank AG. The LCDX index, which allows investors to bet on the U.S. leveraged loan market and rises as confidence improves, rose 0.4 to 94.3 after falling earlier yesterday to as low as 93.25, according to Goldman, Sachs & Co.
Seeking Buyers
In the U.S., mortgage rates for prime borrowers have risen by about 40 basis points compared with May. There is between $1 trillion and $1.5 trillion in mortgage debt seeking buyers and maybe the same amount in asset-backed commercial paper, along with $300 billion of leveraged buyout debt, Bond said.
“In this cycle, it is mostly the lenders, not the borrowers, who are excessively leveraged,” Bond said. As more lenders are forced to go out of business under the weight of subprime-related losses, “fewer lenders, particularly few lenders with apparently unlimited potential leverage ratios, imply less competition to lend and hence a higher overall price for credit.”
Spreads Widen
The spread, or extra yield, of BB rated debt in the U.S. over government debt, widened by an average 84 basis points from 229 basis points at the beginning of July, according to Calyon’s head of Asia credit research Dilip Parameswaran. Before the Asian financial crisis in 1997, the bonds traded at 150 basis points over U.S. Treasuries.
In the five major credit events worldwide since the devaluation of the Mexican peso in 1994, the spread rose between 54 and 224 basis points, he said.
The Fed will cut interest rates significantly after a series of cash injections into the money markets this month had limited effect, Credit Suisse Group said.
The rout in the financial markets is threatening to reverse the outflow of Japanese savings that has been supporting global economic growth, including the capital inflows into China, and it may even be too late to prevent a full unwinding of the carry trade, Credit Suisse analysts led by London-based Jonathan Wilmot wrote in a research report on Aug. 15.
“This is the fundamental source of savings underpinning the global circulation of capital, and the high level of global liquidity, risk appetite and ultimately, economic growth,” Wilmot said.
Taken from Bloomberg.com
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