Markets approach the “drawn-out fundamental downtrend” phase

Euro loans May10.pngSell in May and Go Away” is the oldest rule in stock market investment. This week has certainly provided further support for it:

• The major Western stock markets are down c8%
• The major emerging markets are down between 4% – 13%
• Crude oil prices are down 13%

This May panic may well also mark the markets move into their 3rd, and most destructive phase. As originally identified by Merrill Lynch’s analyst guru, Bob Farrell, “bear markets have three stages – sharp down, reflexive rebound, a drawn-out fundamental downtrend“.

Greece, of course, and its debts, has been the catalyst for this week’s panic. And the chart above (from the Bank of International Settlements), highlights the core problem. European banks have collectively lent $2663bn to the 5 euro countries at most risk of default, the PIIGS (Portugal, Ireland, Italy, Greece, Spain).

The vertical axis identifies the debt held by each country, showing that France has lent $79bn to Greece, and Germany $46bn. As my fellow blogger, John Richardson has noted, “if the whole of Greece suddenly vanished into the ocean, it wouldn’t make that much of a difference to the global economy…including chemicals“. Nor would Portugal, or Ireland.

But Spain and Italy combined are 6% of the global economy, with GDP of $3.6trn. Between them, they owe $1.8trn to banks in the rest of the EU. If markets become seriously worried about the prospects for economic recovery, then they will clearly be near the top of everyone’s concerns. US banks, for example, have $3.6trn of loan exposure to Europe.

This suggests the world economy is now approaching a cross-roads:

• In one direction lies economic recovery, as argued by Larry Summers, US economics chief. His view was that government stimulus would provide, like a 3-stage space rocket, the “escape velocity” to stabilise the major economies and encourage consumers to begin spending again
• The blog, however believes with Pimco (the world’s largest bond fund managers) that we face a “new normal” of lower spending and less debt.

As we move into Budget season, Boards will start to debate their outlook for 2011-3. Clearly they will hope, with Summers, for better times. But prudence suggests they should also plan for a less favourable, Pimco-type Scenario. Markets may well rally again short-term. But if Bob Farrell’s analysis is right, the third phase of the Crisis still lies ahead.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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2 Responses to Markets approach the “drawn-out fundamental downtrend” phase

  1. Richard 9 May, 2010 at 12:34 pm #

    Who have these banks lent money to? The Governments, Greece, Italy etc, or to companies?

  2. Paul Hodges 9 May, 2010 at 4:02 pm #

    The full breakdown of the data is available at the BIS website http://www.bis.org/statistics/consstats.htm

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