The Continent's banks have greater exposure to the U.S. subprime mess than first thought, but no one's clear on just how far it goes—least of all, investors
It's hard to believe that less than two months ago, London's benchmark FTSE 100 index hit a six-year high of 6,754 on the back of upbeat economic news and booming financial-services and commodities stocks. Now, in the wake of the spreading subprime loan crisis in the U.S., the FTSE has given up all its 2007 gains and is trading for the first time since March below the psychologically important 6,000 level.
The carnage continued on Aug. 16, with the FTSE down more than 4%, to 5,859, bringing its decline to more than 13% since the June peak. As in previous sessions, the hardest-hit issues were financials and natural resources, including hedge fund heavyweight Man Group (EMG.L), down 9.2%, and mining giant Antofagasta (ANTO.L), down 10.8%. The sell-off reflected overriding sentiment that there's still more doom and gloom to come before Europe's markets recover from the fallout of the spiraling global credit crunch.
The bears weren't limited to Britain. Nordic exchanges fell dramatically, with Stockholm's OMX 30 down 3.3% and the Oslo index down more than 4%. Worst-hit was Vienna's ATX, dragged down 5.1% by companies such as industrial products makers Andritz (ANDRZ.F) and RHI (RHIV.F). The Paris CAC-40 fell 3.3% and Germany's DAX sank 2.4%.
A Change in Fundamentals?
Is the market meltdown merely a panic reaction to the recent financial instability, or does it reflect a change in fundamentals? Though corporate profits are still strong, analysts and brokerages are pretty bearish about the markets—and a protracted sell-off could eventually have wider ramifications. In an Aug. 15 note to clients, for instance, brokerage Credit Suisse (CS) cautioned that markets were teetering between a "healthy correction" and "something far more sinister that could lead to real economic distress."
Despite the efforts of central banks to prop up credit markets since last week with massive injections of low-cost liquidity, a new mindset vis-à-vis equities appears to have taken hold. Though economic fundamentals remain solid, especially in Europe, and stock valuations are not excessive by historic standards, market experts are steeling for a continued downturn as investors digest the uncertainty created by the credit crisis.
"The desire for asset-backed securities is drying up," says Gabriel Stein, chief international economist at London-based Lombard Street Research. "As a result, we will see bank profits cut and credit growth slowing as there won't be enough money to go around."
ECB's Record Loans
Stein's view is backed up by others in the market. With a host of technical levels currently being tested in the fixed-income, equity, and foreign exchange markets, there is a real chance that bearish factors could snowball into a broader, long-term economic decline. "It feels more dangerous to us than anything we have seen in the current bull market for riskier assets," Credit Suisse says.
To some extent, this contrasts with the view of European Central Bank (ECB) chief Jean-Claude Trichet, who said on Aug. 14 that markets were progressively stabilizing (see BusinessWeek.com, 8/15/07, "Trichet Says Markets Returning to Normal"). To be sure, Trichet was speaking more about credit markets than stock exchanges—and the ECB has won plaudits for its deft defusing of a credit crisis that unfolded starting Aug. 8.
After providing a record $127 billion in overnight loans on Aug. 9 and $159 billion more over the next three business days, the ECB helped cool overnight money-market rates. "We continue to regard the ECB's action as appropriate," says Erik Nielsen, chief European economist at Goldman Sachs (GS). "In times of uncertainty where the consequences of doing too little too late could be catastrophic, you clearly want to do enough and then fine-tune matters as necessary afterwards."
Confusion Among European Banks
But having smoothed worries in the credit markets, the ECB may have spooked stock investors even more. After Germany's IKB (IKBG.DE) and France's BNP Paribas (BNPP.PA) last week revealed larger-than-expected exposure to the subprime mess, financial players are unsure how other European banks could be affected (see BusinessWeek.com, 8/10/07, "All Eyes on the ECB"). More than anything, it's the lack of transparency among European banks into their exposure to the U.S. subprime mess that unnerves investors.
This uncertainty has exacerbated the equity sell-off as investors seek to secure their capital before any future subprime-related announcements. "More exposure [by European banks] will come out in the wash," says Lombard's Stein. "It just beggars belief that they don't hold any subprime assets." Even the banks aren't sure what they own or how to value it. One European banker says he thinks it will take the rest of the year for banks to sort out their asset portfolios and stabilize their funds.
Even in such a pessimistic environment, some advisers see opportunity. In an Aug. 13 research note, Morgan Stanley (MS) chief European equity strategist Teun Draaisma counseled that this was the right time to buy European stocks, citing strong company balance sheets and continued merger-and-acquisition activity to counteract current bearish trading. "Markets hate uncertainty and there is a lot of it around currently," Draaisma said. "But one has to buy at the moment of maximum uncertainty, and in our judgment now is close to such a moment."
That may be true for investors with strong stomachs, but it's little comfort for shareholders who have taken big losses in the recent downturn. As analysts seek to quantify the risk to European equity markets from the U.S.-led credit crunch, two things are now clear. Europe's banks, both big and small, have greater exposure to subprime than first thought, and market uncertainty will continue until the extent of this exposure is discovered. Unfortunately for investors, it may take the rest of this year for clarity to emerge.