A bull market is still some way away

Business Times - 13 May 2008


A bull market is still some way away

STOCK market bulls have been quick to proclaim the end of the bear market and the re-emergence of a fresh bull. The turning point, it is said, came in March when the US Federal Reserve helped bail out failed US bank Bear Stearns and announced various extraordinary term lending facilities that flooded credit markets with liquidity, thus helping ease strains. Since then, stocks have rebounded smartly, by an average of 10-15 per cent worldwide in the hope that the worst is over. Last week, US Treasury Secretary Henry Paulson spoke of the worst being behind us and that he is 'feeling better about the markets'.

Should everyone share this optimism? While there is some room for encouragement today compared to two months ago, there is still plenty to worry about that investors may have glossed over. An easing of pressure in credit markets may mean that credit conditions have improved, which in turn suggests that this particular facet of the crisis may be over. However, it does not necessarily mean that the impact on earnings and the economy has been fully discounted, nor does it herald an immediate return of strong, bull market-quality growth.

A skyrocketing oil price at around US$125 now is one problem that markets have under-appreciated. Even the most optimistic observers now concede that a price of US$200 per barrel within the next few years is a realistic possibility, a level which was inconceivable as recently as four years ago when the price was US$35. Needless to say, oil at such high levels would seriously damage growth. Combined with record-high commodity prices, the resultant inflationary pressure means that central banks everywhere will find their hands tied when it comes to lowering interest rates.

The Fed was among the first monetary authority to signal this when it cut its federal funds rate from 2.25 per cent to 2 per cent at its April 30 Open Market Committee meeting but said that 'uncertainty about the inflation outlook remains high', a statement that may be interpreted to mean that the present easing cycle is at, or very near, an end.

Furthermore, the Bank of England last Thursday left rates at 5 per cent, dashing hopes that a string of weak UK economic data might have prompted an easing, while the European Central Bank also kept rates unchanged at 4 per cent. If these moves are an indication of things to come, then it's possible that the months ahead would see higher interest rates. The full effects of the sub-prime crisis may not be reflected in the economic numbers yet. Moreover, there is the possibility that a severe slowdown could trigger a second wave of defaults, this time in corporate and consumer debt. If this occurs, the consequences for banks could be painful.

All told, the best that can be said is that although pressures have eased in credit markets, the repercussions of the sub-prime crisis may not have fully played out yet and it would be premature to assume that a bull market has returned.

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