Thursday, November 8, 2007

Investors Flee Equities

Equities bore the brunt of another turbulent session on Wednesday as the dollar fell to record lows, and oil and gold set highs for the year before receding in late trade.

Wall Street's losses accelerated in the afternoon, led by financial stocks. Leading stock benchmarks have surrendered all their gains that followed the Federal Reserve's rate cut in mid-September.

The S&P financials sector has fallen more than 20 per cent from its high in February, satisfying the definition of a bear market.

Brian Gendreau, investment strategist at ING Investment Management said: "There's a sense that the problems in the financial sector related to subprime just aren't over yet. Investors were hoping the banks would get the bad news out in the third quarter and it would be over. If there continues to be a problem in financials, that drags down the whole market."

Investors flocked to the safety of government debt as various measures of risk aversion flared. The Vix index, a measure of volatility in US equity markets and often referred to as Wall Street's "fear gauge", rose 24.2 per cent.

Concerns over further profit writedowns were never far away, as Washington Mutual and Capital One both raised their provisions for future credit losses. Morgan Stanley came under renewed suspicion after Deutsche Bank said it expected an additional writedown of between $3bn-4bn related to collateralised debt obligations at the US investment bank in the fourth quarter.

The Dow Jones Industrial Average closed down 2.6 per cent. General Motors fell6.1 per cent after it was forced to write down the value of future tax benefits and posted a record quarterly loss. The S&P 500 shed 2.9 per cent and the latest slide in the dollar means that the S&P has fallen 6.3 per cent in euro-denominated terms for 2007. The Nasdaq Composite was 2.7 per cent lower.

"Higher commodity prices combined with some downbeat corporate earnings news out of the US, is certainly taking a toll on equity markets," said Jimmy Yates, a trader at CMC Markets.

As investors shunned stocks, government bond prices rose sharply. Treasury bills were highly sought and the the two-year yield fell 12 basis points to 3.57 per cent. The difference between two-, and 10-year yields rose to its steepest level since April 2005. In another sign of risk aversion, the two-year dollar interest rate swap spread closed at 80bp over the two-year note yield, its widest level since 2000. The spread, which is a measure of flight to quality concerns between Treasury and money market collateral, is up from 72 bp at the start of the week. The yield on the 10-year Treasury fell 3bp to 4.33 per cent, and the sale of $13bn in new notes merited reasonable demand, said dealers. In Europe, the yield on the 10-year Bund fell 5.7bp to 4.14 per cent, while the 10-year gilt yield slipped 2.7bp to 4.83 per cent.

On currency markets, comments by a senior Chinese politician raised expectations that strong currencies, such as the euro and the pound, would be used in its reserves portfolio to counter the weakness of the US currency. The dollar hit a low of $1.4730 against the euro, and fell to a 26-year trough of $2.1071 against sterling. The dollar index, a measure of its value against a basket of currencies, set a record low of 75.077 and is down nearly 10 per cent this year.

Marc Pado, chief market strategist at Cantor Fitzgerald, said this increased the dilemma for the Federal Reserve. "It puts the Fed in the box over cutting rates," he said. "How do you cut rates to save the financials when the dollar is getting killed? That's the crux of the whole matter."

Commodity markets were volatile. Nymex West Texas Intermediate reached a record $98.62 a barrel, but settled 33 cents lower on the day at $96.37 a barrel. A smaller-than-expected slide in inventories sparked the pullback in prices, said traders. Spot gold in London reached a new 28-year peak of $845.40 a troy ounce, but also staged an afternoon retreat.

The fresh high in oil prompted Frederic Mishkin, a governor of the US Federal Reserve, to warn about the short-term impact on inflation. US inflation expectations, as measured by Treasury Inflation Protected Securities, neared their highest levels this year, before contracting noticeably in afternoon trade.

The White House expressed concerns over the strength of crude yesterday. "Oil prices are entirely too high," said Dana Perino, White House spokeswoman, warning also of the effects on the economy.

European equity markets were undermined by weak carmakers and luxury goods groups - export-focused sectors whose US earnings are being dented by the dollar's steady decline. Jeffrey Palmer, head of global equity strategy at UBS, said: "The strong euro is now suggesting European earnings will slow - and this trend could continue for some time," he said.

Meanwhile, airlines became the focus of several analysts due to rising concerns that traffic numbers would not offset the impact of higher fuel prices. Mr Palmer added: "Although we question whether energy prices can withstand current levels, heavy users of energy are going to suffer." The FTSE Eurofirst 300 ended down 0.7 per cent at 1,543.55, with airlines British Airways and Lufthansa among those worst hit.

Asian markets are following the dive as Nikkei-225 falls over 400 points and HangSeng exceeds 1000 points in its plunge today so far.

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