Sub-prime strikes again

11 April 2008

It will not be a very merry Christmas on Wall Street this year. Some of the most senior bankers in New York have already lost their jobs, most notably Merrill Lynch CEO, Stan O“Neal, who left after US$ 8,4 billion (€ 12,4 billion) of write- downs and a US$ 2.2 billion loss for the third quarter, and Citigroup's chairman & CEO Charles Prince, who had to go after US$ 12 billion (€ 17,8 billion) of write-downs.

Although both individuals will take solace in their reported US$ 161 million (€ 104 million) and US$ 100 million (€ 68 million) compensation packages respectively, their departures underline the difficulties banks around the world continue to face in the wake of the crisis in US sub-prime mortgage lending.

Major job cuts are also expected throughout the banking fraternity, as profits come under even more pressure in the face of a slowdown, if not full-blown recession in the US. Citigroup alone is thought to be planning to bring the axe down on anywhere between 17000 and 45000 employees.

All this bad news had a dire effect on stock markets, with benchmarks around the world falling heavily in November. The worst affected was the Nikkei 225, which lost -8,57% of its value between weeks 43 and 47. The Dow also fell sharply, with a -6,41% loss, taking it below the 13000-point mark for the first time since April.

The major European indicators were not hit quite so hard, but still lost ground. The FTSE 100 fell -5.93% and the CAC 40 -5,41%, while the DAX was let off relatively lightly with a -3,98% drop.


By comparison, the construction sector suffered an almighty thumping. The CET Index lost a huge -11,93% to finish week 47 at 186,82 points, it's lowest since mid-December 2006.

The heaviest losses were seen among equipment manufacturers, with the CEE Index for the sub-sector dropping -15,83% to 226,15 points. This was the lowest the Index has plunged since the end of April.

As one would expect, the bad news was spread across the companies that make up the CEE, with falls in excess of -20% in several cases. The only one to escape unscathed was Deere, which enjoyed a +2,14% rise.

Although the company, which is generally regarded as no.2 in the US construction equipment market, saw its sales hit hard by the slowdown in America's residential construction market, sales of this type of equipment account for only about 20% of its revenues. According to results for its financial year ending 31 October, its other divisions – agricultural and consumer equipment – had a strong 12 months, hence the share price rise.

Materials producers also had a torrid time in November, with the CEM Index dropping -9,85% of its value between weeks 43 and 47. It ended week 47 at 132,19 points, an 18-month low.

Again losses were widespread, and although heavy in places, materials producers did not suffer quite as badly as equipment manufacturers. There were also two gainers, with both Cimpor and Heidelberg Cement seeing marginal rises in the share prices.

Both were helped by up-beat third quarter results announcements in early November. In Heidelberg's case, it was able to report Hanson's performance in its figures for the first time, and this bumped up its revenues +22% for the first nine months, compared to the same period in 2006, while its net profits were +156% better.

Losses were more limited for European contractors, with the CEC Index for this sub-sector dropping -6,36% to 232,87 points by the end of week 47. This was just below the level at which the Index started the year.

Although falls in the sector were more restrained, this reflected both heavy losses for some companies and useful gains for others, most notably the large Spanish groups. Acciona, ACS and Ferrovial all managed respectable rises over the four-week period.

Again, strong third quarter results seemed to underpin these gains, with profits for the first net nine months up +25,3% for Acciona, while ACS saw a +108% rise and Ferrovial a +142% increase. Vinci's marginal gain of +0,58% was also results-driven, with a +15,5% rise in revenues for the first nine months of 2007.

But elsewhere in the sector things were grim. Ten of the companies that make up the CEC saw their share prices fall by -20% or more, with NCC seeing the biggest loss – -33,29%. It was only the fact that the four companies which did gain are so highly capitalised that the losses for the CEC were not heavier. Between them Acciona, ACS, Ferrovial and Vinci account for about 40% of the CEC, and Vinci is the largest company listed, with a stock market value of just over € 25 billion.


The worsening economic outlook in the US saw the Euro climb to new highs against the Dollar. Over the four weeks to the end of week 47 it gained another +4,16% to finish with one Euro worth US$ 1,483. A similar set of circumstances in the UK – an economic slowdown and the prospect of interest rate cuts, also saw the Euro climb sharply against the Pound. Over the same period it put on +3.68% to finish at € 1 = UK£ 0,72 (or UK£ 1 = € 1,39).

The Euro also appreciated strongly against most of the other European currencies, most notably the Romanian Lei, where it put on more than +10% in four weeks.

These gains are generally attributable to strengthening economic conditions in the Eurozone, compared to the down-slope of the cycles that are being seen in the US, UK and some other parts of the world. Most notably, the German economy is showing reasonable growth, despite being hampered by the high price of oil and the strength of the Euro weighing on its exports.

The value of the Euro is becoming an increasingly politicised issue, most notably with French president Nicholas Sarkozy warning of “economic war” should the current imbalance with the Dollar continue.


The end of the year is traditionally a quite period for the investment community, ahead of the annual results season getting into full-swing in late January. Absent of any positive news, it seems most likely that the intervening eight weeks or so will see a continuation of Novembers trends – falling share prices and further slides for the US Dollar.

Looking ahead to next year, full-year results for 2007 will be even more keenly watched than usual. If the banks come out with more write-downs, share prices will fall further and a full-blown recession in the US will become a bigger possibility.

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