November 2007

Banks are currently in turmoil as the effects of subprime exposure continue to weigh. Often referred to now as ‘subprime slime’ or ‘toxic debt’, during this past month we have witnessed the departure of the CEOs of both Merrill Lynch and Citigroup. With both these institutions heavily exposed to an area of the debt markets with which we have all now become very acquainted, it was almost inevitable that these top dogs had to fall on their swords. The big question remains though: which other banks have exposure which we as market watchers do not know about yet ? This uncertainty is fuelling the incessant downside pressure on banking stocks. Looking at the charts, it is difficult to see where the bottom may be. UK Banks are keeping very quiet despite massive slides in their share prices.

CDOs (collateralised debt obligations) and SIVs (structured investment vehicles) are complex repackaged loans which although once possessing a value are now largely worthless. Instititions (banks) invested in these securitised debt issues believing them to be close to investment grade stocks, perhaps without fully understanding them. The rest is now history. Multi billion dollar write offs have temporarily become the norm; this despite recent reassurance from the US Fed Reserve bank telling us that it felt we were over the worst in this regard !

As if the credit market woes were not enough to concern us, we currently are also having to deal with oil at over $90 per barrel (and the inflationary impact of this), a softening in the property market (and the potential knock on effects here to consumer confidence) and the dollar trading at record lows versus the Euro. Well at least it might be a decent time to go Christmas shopping in New York.

Despite the above, October in general was a solid month (albeit volatile to the tune of approx 270 points) for equities and there was no crash as some were nervous of on the 20th anniversary of the 1987 slump. Miners and telecom stocks again traded strongly and were collectively responsible for keeping the blue chip index steady. The aforementioned banking sector, selectively retailers and house builders / property stocks remained weak markets. In terms of corporate activity, Scottish and Newcastle received a takeover approach from Carlsberg and Heineken, Alfred McAlpine received an approach from rival Carillion and England football sponsor Umbro may fall prey to US market leader Nike.

The Bank of England kept UK base rates on hold at 5.75 % via a comprehensive 8 members to 1 vote and the US Fed reduced both the base rate and discount (interbank) rate by a further 25 basis points. Fed funds (base rates) futures are pricing in at virtually 100% certainty further cuts from the Fed.

Last month I described the market as climbing a wall of worry focusing positively on the future, a future where Anglo American recessions will be avoided with credit markets reverting to relative normality. As I write this month, there is a higher fear factor relating to the increasing possibility of economic slowdown fuelled by the continuing fall out from sub prime and the ever weakening dollar. Further US rate cuts could lead to a further weakening of the dollar something the Chinese are getting jittery about reference their liquid reserves.

As the year end approaches the market requires clarity from the banks; we have trading statements due from Barclays at the end of this month and Royal Bank of Scotland in early December. Have these shares been oversold on fear ? If the sector can finally turn up, with it representing circa 30% of the index, we could yet have a seasonal Santa Claus rally and a retest of the 6750 annual highs.