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The Dow Jones index fell close to 700 points intraday in the wake of a five-point programme outlined by the Group of Seven to alleviate the current crisis, but recovered to end 128 points, or 1.5%, down at 8,451 points. Even so, the US stockmarket recorded its worst weekly performance ever û as did the Tokyo market û despite a series of measures by the authorities to counter the lack of investor confidence and to improve the liquidity in their respective banking systems. Among the measures was an unprecedented coordinated half-point rate cut by the US Federal Reserve, the European Central Bank, the Bank of England and the central banks in Canada, Sweden and Switzerland. Rates were also eased in Australia, Hong Kong, China, South Korea and Taiwan, while India lowered the cash reserve ratio for the countryÆs banks to make it easier for them to lend.
On the previous weekend, the US Congress had also passed the controversial $700 billion ôbailoutö package, referred to as the Troubled Asset Relief Programme, or Tarp, after numerous additions aimed at protecting taxpayers and mortgage holders.
Neither of these moves had little positive impact, however, as banks remain unwilling to lend to one other, worried that they could end up with the raw end of the stick if another financial institution collapses. According to analysts, banks are also hoarding cash in case depositors start to withdraw their funds en masse. In Hong Kong, where the de-facto central bank eased its key interest rate by 1.5 percentage points in two separate moves over two days, the Hong Kong dollar interbank offered rate shot up to 4.408% on Friday from 3.85% on Monday before the move.
ôThe problem is that there is no counterparty trust in the interbank market which stems from the disruption caused by Lehman going into bankruptcy,ö says Adrian Mowat, J.P. MorganÆs chief equity strategist for Asia and emerging markets.
The coordinated rate cuts came after the credit crunch started to have a major negative impact on the financial sector in Europe. In Iceland the government was forced to take control of all three of the countryÆs banks to prevent a collapse and at least three other European lenders had to be bailed out by public sector money in the past week alone.
The Dow Jones index dropped 18.2% over the week as a whole, while in Asia, the Nikkei 225 plummeted 24.3%, Hong Kong lost 16.3%, Mumbai 16%, Singapore 15.2% and South Korea 12.6%.
In Indonesia, the benchmark index fell 20.8% in less than three days, prompting the regulators to shut the market mid-way through WednesdayÆs trading session. The market was scheduled to re-open on Friday, but after the sharp downturn on Wall Street overnight, a decision was taken to keep the market closed û a move that analysts say was a mistake as it will make investors wary of committing money to the market in the future and is bound to lead to a higher cost of capital for Indonesian corporates.
A key reason for the stockmarket sell-off appears to be a lack of confidence among investors that the authorities will actually be able to alleviate the crisis from spreading further. This is not entirely surprising since one of the major reasons for the credit crisis in the first place, according to several high-profile economists, is the loose monetary policy pursued by the Federal Reserve over the past five years. The scepticism has been further fuelled by the fact that US treasury secretary Henry Paulson was able to get his bailout programme through the House of Representatives only on the second attempt and as the repeated offers of short-term liquidity to the banks is having seemingly no impact on short-term rates.
Asia-based investor Mark Faber has also repeatedly argued that injecting more liquidity into the US banking system to counter a crisis that was caused by too much liquidity in the first place is simply not the right way to go about things.
In his Greed and Fear newsletter to clients dated October 9, CLSAÆs equity strategist Chris Wood said it was ôsomewhat shockingö to find investors not taking more comfort from growing official actions to alleviate the credit crisis, but added that at the same time it was healthy since it is part of the cleansing process that will be the consequence of this continuing cycle of debt liquidation.
ôIt is also rational since those in authority have been so wrong in just about every official pronouncement they have made on the credit crisis during the past 18 months that investors should not be expected to believe any longer in the immediate efficacy of their policy actions,ö Wood wrote.
Adding to the fear, the past week has also seen a renewed focus on what the prolonged credit crunch and financial crisis will mean for the global economy. Not surprisingly, talk of a potential global recession hit AsiaÆs export-dependent economies hard and does at least partially explain the sell-off in the regional stockmarkets.
The regional growth concerns became all the more real when on Friday morning Singapore announced preliminary third quarter GDP data, which showed its economy was already in a technical recession. Later in the day, India said its industrial production grew by only 1.3% in August, well below economist forecasts of about 6%. And in Japan, Yamato Life Insurance filed for bankruptcy citing stockmarket losses, while New City Residence Investment Corp became JapanÆs first real estate investment trust to go bust after it ran into difficulties raising money to repay its debts û a failure that could signal further trouble in the countryÆs Reit sector, which according to Reuters has lost about two thirds of its value since the peak in May last year due to weakness in the property market and the drying up of credit.
All this contributed to the aversion against equities. However, the severity of the collapse in share prices and the broad-based nature of the selling û defensive sectors like utilities were down only marginally less than manufacturing stocks û was a clear indication that the sell-off was anything but rational. But while panic was certainly spreading, analysts note that most of the selling in Asian stockmarkets this past week was due to redemptions, margin calls or primary brokers calling the clientsÆ credit lines û in other words, a lot of it was ôforcedö selling by asset managers who had no way of coming up with the required cash except to liquidated part of their remaining equity holdings.
At the same time, there were really no buyers as few investors are willing to commit capital until there is an improvement in the interbank market.
ôEquity investors know there is no point to stand in the way of this redemption train and they donÆt want to commit capital until there is a turn in the credit markets,ö says Mowat at J.P. Morgan. ôThe lesson for the past four to five years has been to æbuy on dipsÆ, now it is æsell on a riseÆ.ö
However, Mowat, Wood û and others û believe Asian markets could see a sharp rally once short-term money market rates stabilise on the basis that Asia is still likely to outperform the US and Europe in terms of growth. And even if key indexes only return to the levels they were trading in early August (which would still leave them down on the year) it would mean gains of up to 40% from current levels, Mowat says.
As of FridayÆs close, IndiaÆs Sensex index was off 48% this year, JapanÆs Nikkei was down close to 46%, Hong Kong was off 47%, Singapore 44%, Taiwan 40% and South Korea 34%.
Despite the scepticism, the latest measures announced by financial leaders are more in line with what analysts have said is needed to dig the global financial sector out of its current rut and thus may end up providing some stability once they start to be implemented. Treasury secretary PaulsonÆs admission that the US government will be prepared to take direct equity stakes in ailing lenders, as opposed to just buying the bad assets on their books, for example, is just what many market watchers have been calling for and puts the USÆs rescue efforts largely on par with those announced in the UK.
Meanwhile, the G7 member countries vowed to protect major banks and to prevent their failure; committed to working to get credit flowing more freely again; to support the efforts of banks to raise money from both public and private sources; to safeguard bank depositors; and to revive the battered mortgage financing market. The G7 includes Britain, Canada, France, Germany, Italy, Japan, and the US. The five-point plan was later endorsed both by the Group of 20 nations and the International Monetary FundÆs policy-guiding body, which met separately over the weekend.
CLSAÆs Wood said the fact that policymakers have finally begun to ôget realö means that policy will now be the main driver of world financial markets, and that policymakers have finally capitulated and accepted that the crisis is systemic in nature and therefore requires a systematic policy response rather than a series of ad hoc measures.
ôThis does not mean that governments and central banks can now wave a magic wand and make everything better. Nor does it mean that bank lending is not about to slow dramatically on a trend basis in the Western world; nor that Western economies will not go into recession. But it does mean that the policy response is likely to improve from here and that the complete breakdown of the global financial system has a much better chance of being avoided.ö
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