Conflict hits the markets

24 April 2008

July's outbreak of open hostilities between Israel and Hezbollah, the militant Lebanese political group, and Israel's bombing of Lebanon's civilian infrastructure pushed tensions in the Middle East to a new high. This sent oil prices briefly above US$ 78 (€ 61,5) per barrel, and the implications of this - inflation, slower economic growth, and lower profitability - prompted another big sell-off on the world's stock markets.

Prior to the crisis, markets were showing signs of recovering from May's slump, which came on the back of poor inflation data from the US. However, these recent improvements were more than wiped-out in week 28 and 29, with the sharp escalation of hostilities in Lebanon.

Equipment

Late-May to late-July saw heavy losses across the board in the equipment manufacturing sector, particularly for the US companies. Some of these suffered share price drops of -20% or more over the two months, and only a handful of companies in the sector - Doosan Infracore, Pinguely Haulotte and Volvo - achieved net gains during this difficult period

Despite the current malaise, two stock splits took place between weeks 21 and 29 - Sandvik split its equity on a 5-for-1 basis, and Terex performed a 2-for-1 share split. The purpose of such moves is to increase the number of shares available to the markets - doubling the number in Terex's case and a five-fold increase for Sandvik - with a proportionate reduction in share price so the capitalisation remains the same.

Stock splits are therefore positive moves for companies that undertake them. They indicate high demand for shares and a strong price.

In contrast to the big losses and variations in the equipment sector, materials producers' shares were fairly uniform over the mid-summer. The CEM Index lost -3,20% in eight weeks, and the drops for its component companies were of a similar size. Saint-Gobain managed a marginal gain of +0,09%, while the biggest faller was Wolseley at -9,52%.

The contracting sector was much more mixed, with performances varying from some big losers (Amec and OHL) right through the spectrum to some substantial gains (Eiffage and Strabag). The net result was negative, with the CEC Index dropping a fairly mild -1,46% in value.

Currencies

Week 28 was marked by the Bank of Japan (BoJ) lifting interest rates up to 0,25% from 0%, where they have languished for more than six years. The hike was widely anticipated by the markets, and was more symbolic anything else - there is not a great deal of difference between borrowing at 0% and 0,25%.

But that symbolism is important. It indicates further confidence in Japan's recovering economy, and a new policy direction for the BoJ that should see the Yen appreciate over time.

In contrast, US Federal Reserve chairman Ben Bernanke indicated it could be time to back down from the aggressive rises of the last two years or so.

The Euro lost -1,25% against the US Dollar over the last eight weeks, and it also slipped slightly against the British Pound, Korean Won, Polish Zloty and Swedish Krona. However, there were good gains against the Hungarian Forint and Japanese Yen, along with more marginal improvements against the Czech Koruna, Danish Krone, Norwegian Kroner and Swiss Franc.

Outlook

The sudden escalation of hostilities between Israel and Hezbollah in July threatens to further destabilise the Middle East and sour relations with the US and Europe. If a sustainable ceasefire is not achieved, oil prices will sky-rocket.

As it is, the late summer hurricane season in the Gulf of Mexico threatens to push the price of a barrel above US$ 80 (€ 63). If this is combined with greater instability in the Middle East, prices could well break the all-time high that was seen during 1979's Iranian revolution - about US$ 85 (€ 67) per barrel at today's prices.

At those kind of levels economic growth would certainly slow, and recession would be a genuine risk.

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