Western markets' correction heads toward a slump

By Neville Bennett

Friday 26th July 2002

Wall Street and the European (but not Asian) markets are in a panic. Defined as a 10% drop in value in 30 days, panics are a frequent historical phenomenon.

There were 98 panics on Wall Street from 1890 to 1990. Scott Joplin had his ear tuned to them when he wrote The Wall Street Rag, with the line "Panic in Wall Street, Brokers feeling melancholy."

Melancholy is a mild word to describe street sentiment now: "capitulation" is often heard. Most of the US indices are now back to their 1997 levels. The gains of the past five years have evaporated. Europe has also hit five-year lows, the FTSE has hit a six-year low.

A decline in market prices is not unexpected. Ever since the "tech-wreck" took wind out of the Nasdaq's sails, there has been a slow decline. This decline is now in its third year. This price correction was expected by many analysts as a normal part of the investment cycle. Some welcomed it as providing a new round of profitable opportunities.

In the past few weeks the mood of resignation in accepting a shakeout, has changed with increasing inputs of anxiety. The market was able to robustly absorb the shock of the Enron collapse. Poor earnings were also accepted. The mood changed when it emerged that corporations, such as WorldCom, had been cooking the books. More are expected. Moreover powerful bankers, such as Citibank and JP Morgan's share price has been trashed, because of a suspicion they advised clients to adopt dubious accounting practices. Disgust and distrust added to melancholy.

The defences against further falls are not strong. There has been a bull market for 10 years and too many people thought the cycle of advance and decline had been changed for a linear increase. US fund managers had very low cash holdings as cash earned around 2%. When the first nervous fundholders redeemed their shares, the funds had to sell stock. A trickle may become a torrent. Money dries up in panics. European markets are suffering from a withdrawal of American money. As the market recedes, investors have to think of unfamiliar defensive strategies.

The insurance sector is hard hit in Europe. Insurers maintain huge capital reserves to cover their risks. Although they diversify, their holdings have been heavily weighted toward equities because it was believed equities gave growth and dividends. Insurers benefit in rising markets because investors know the companies have made capital gains on their holdings. Equally, the share price of insurers themselves goes down with the market. All insurers are now vulnerable to falling further because the large Fortis group has revealed that the value of its portfolio has fallen below purchase price for the first time in history and unrealised losses must be charged against operating profit. Insurers will lead the market down and also accelerate a fall by being forced to sell stock to maintain liquidity.

Telco stocks are very vulnerable, having incurred huge debts in buying assets.

This sector, like many manufacturers, will seem vulnerable as business is not likely to be buoyant enough to generate the profits necessary to service their debts.

There will be further flights to gold, oil and bonds.

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