Down, down, down

18 March 2008

There aren't many fund managers or investors in Europe that would have enjoyed a relaxing and peaceful summer break this August. The turmoil on the world's stock market, triggered by problems at the high risk end of the US credit market, wiped trillions of Euros off the value of equities.

Markets were extremely volatile throughout August, with prices swinging wildly. At the time of writing they were still yet to settle and find steady levels. However, the net effect through all the sharp dives and rebounds has been pronounced.

Between week 28 and 34 the Dow saw a net loss of -5,13%. But, as is often the case, indicators outside the US reacted more violently to the problems in North America. The falls for the European indicators were more pronounced at -6,76% for the FTSE 100, -7,22% for the DAX Xetra and -9,30% for the CAC 40. Most dramatic of all was the -10,80% fall for Japan's Nikkei 225.

Construction Shares

Being cyclical stocks, shares in the construction sector tend to see more exaggerated movements than those of the mainstream market indicators. This was very much the case throughout August, with losses for the GET Index for the whole industry coming out at -12,56% over the six-week period.

The hardest hit was the Materials sector, with the ceM Index falling -16,47%. However, it should be added that about six percentage points of this fall was due to the removal of Hanson from the Index, following the completion of Heidelberg cement's acquisition of the UK company. Without this effect the Index would have been down by-10,34%.

Even without this unfortunate bit of timing, it was a grim six weeks for the sector. Every company within the ceM saw its share price fall, the steepest losses being seen by CRH, Italcementi and Lafarge. By comparison, Heidelberg cement and Kone were let off relatively lightly with falls of -4,89% and -3,66% respectively.

Heavy losses were also the order of the day for contractors' shares, with the ceC Index for the sector dropping -11,86% over the course of six weeks. However, there was some good news from the UK, with both Balfour Beatty and Taylor Wimpey seeing small gains in their share prices.

Both rises were related to half-year results announcements. Taylor Wimpey, the company formed in July from the merger of Taylor Woodrow and Wimpey, used its first interim statement to announce an unexpected UK£ 750 million (€ 1,1 billion) share buy-back, which will be carried out over the next 18 months.

Balfour Beatty's share price went up on the back of better than expected 'adjusted' profits for the first half of the year and a strong order book. The improvement in basic profits did not include a one-off charge of UK£ 103 million (€ 151 million) relating to the collapse of Metronet, a consortium that Balfour Beatty owned 20% of, which was responsible for maintaining large parts of London's underground railway network.

But elsewhere in the contracting sector share prices fell throughout the six-week period. A few companies saw only marginal losses, but double-digit falls were very much the order of the day. The steepest of these was Impregilo's -22,12% fall.

Least affected of the construction segments, but still seeing a steep fall was the equipment industry. The ceE Index for the sector was down -9,64% between weeks 28 and 34 Not as bad as the ceC or ceM, but still a more severe drop than was seen for any of the mainstream indexes in the US or Europe.

Like the materials sector, every equity that makes up the ceE fell during the six-week period, and double-digit losses were the rule rather than the exception. The biggest fall was for Gehl's shares (-26,89%). The company has been hit by the double-whammy of the volatility of the markets plus the fact that, as a US-based maker of compact equipment, its fortunes rely heavily on the declining US residential construction market.

A few companies in the sector were let off relatively lightly however, and Astec Industries, Bell, Deere, Metso and Palfinger stand out as seeing only marginal share price falls. Unlike Gehl, Astec, Bell, Metso and Palfinger have relatively little exposure to the US residential sector, which seems to have helped them weather the storm.

The same could not be said of Deere, which is no. 2 in the US construction equipment market behind Caterpillar. However, third quarter results for the company (it uses an October to October financial year) revealed better than expected profits, with higher sales of agricultural, landscaping and consumer machinery more than offsetting a -20% fall in construction and forestry equipment.

Currencies

The various ups and downs of share prices have also had an impact on exchange rates, particularly as several central banks have been intervening in various ways to steady the markets. Many have increased the supply of money in the face of tightening commercial credit conditions, and in the US the Federal Reserve cut its Discount Rate for direct loans to banks by -0,50%.

But despite this rate cut in the US, it was the Euro that fell during late July and August. Despite a marginal gain against the Pound it was down -1,63% against the Dollar, -1,28% against the Swiss Franc and a huge -6,55% against the Yen.

The Yen is a particularly interesting one. Having sunk over the last few months against the Dollar, and to record lows against the Euro, investors have now decided that it looks under-valued. Economic growth in Japan seems to be improving, while the current cycle seems to have peaked in Europe and has started to fall away in the US, and this is the key driver for the Yen's rebound.

Outlook

Share prices may have taken a battering this summer, but it's not the end of the world just yet. For example, despite its problems the Dow is still about +6% higher than it was at the start of the year, and the ceT Index is up +9% for the year to date.

Less encouraging is the FTSE, which has fallen back to the level where it started the year, while the Nikkei has a net loss of -5% against it for the first eight months of the year.

It remains to be seen where the markets finally stabilise, but it is important to keep the situation in perspective. Despite all the recent troubles, key indicators like the Dow are still performing better than other investment instruments such as bonds and savings.

Naturally the long-term outlook is difficult to call at the moment, but with good economic growth around the world (with the possible exception of the US), a market recovery seems a little more likely than a prolonged decline.

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