One MBA bull pulls in his horns

Did the worst trading day on Wall Street since September 11, 2001, change the minds of our contributors to the Eureka Report Market Bottom Assessor?

Yes, slightly.

But first to recap: the number of US investment banking giants has dwindled from five to two, after Lehman Brothers spectacularly filed for bankruptcy this week and Bank of America agreed to buy Merrill Lynch for $US50 billion.

The US Federal Reserve allowed Lehman Brothers to fall, but it was a different story for American International Group.

With the US insurance giant teetering on the edge of collapse, the Fed stepped in with a $US85 billion loan to protect financial markets from the largest-ever corporate bankruptcy.

In return, the US government will have an 80% stake in IAG, with the right to veto dividend payments to common and preferred shareholders.

These unprecedented events have pushed Australian investment banks south, with Macquarie Bank and Babcock & Brown severely punished during this week’s trading. Macquarie has slipped below the psychological $40 mark, while besieged Babcock slumped from $1.90 on Friday to close at $1.05 on Tuesday.

And it’s not just the investment banks that have suffered. The Big Four retail banks have come clean on their exposure to Lehman Brothers and related businesses: the ANZ exposure was about $US120 million, CBA’s exposure was less than $150 million, NAB’s was less than $100 million, and Westpac’s was less than $10 million. Not surprisingly, the banks’ share prices dropped in the first two days of trading, although Westpac bucked the trend by rising slightly on Tuesday.

So have the contributors to the Eureka Report MBA (Market Bottom Assessor) changed their tune on whether the Australian market has bottomed?

For two weeks now, five of our contributors have said the worst was over (green lights); three have said there is more bad news to come (red lights), and two have been somewhere in between (amber lights).

Our weekly survey of Australia’s leading analysts, economists and stockbrokers now shows a slight souring of sentiment; CommSec chief economist Craig James no longer believes the Australian market has bottomed. He has switched from green to amber this week, citing ongoing instability in the US.

James’ move means the balance now sits as follows: four say the market has bottomed, three say there’s more bad news on the way, and three are undecided.

Joseph Palmer & Son’s Allan Furlong says irrespective of the “doom and gloom” headlines, the US economy has stabilised, adding that now is a good time to buy cheap stocks.

Fellow bull Ed Prendergast, of Pengana Capital, says the Australian economy is in better shape than originally feared and at some stage the bad news from the US will pass and investors will return to fundamental, stock-specific analysis.

Of the amber lights, BT Financial Group chief economist Chris Caton advises readers to keep an eye out for more “bumping along the bottom”. Caton says financial market ructions will not disappear quickly, and although he sees a short-term rally along the track, he argues the sharemarket will not get any traction until world growth prospects show improvement.

Meanwhile, the bears say the ongoing turmoil in the US suggest there is more downside over the next month or so. Clime Capital’s Roger Montgomery says we needed more than six months to rebalance balance sheets after 15 sheets of bingeing.

Fellow bear, ANZ chief economist Saul Eslake, says the recent carnage in the US means we’re closer to that bottom than before; now the fears have been realised, the fear will dissipate, so to speak. Eslake also warns the market has not factored in the implications of a US recession, which is now looking more likely than before.

So has the market bottomed?

Allan Furlong
Manager client services, Joseph Palmer & Son

Yes. The non-financial services economy of the US will likely strengthen due to the bailout of Fannie Mae and Freddie Mac, and the OECD has just raised its full-year growth forecast from 1.2% to 1.8%, thus implying that the world’s largest economy has stabilised, irrespective of the “doom and gloom” headlines surrounding the financial system. Interestingly, I was reviewing the closing stock prices of many of the components of the ASX20 today (Monday) and guess what? Despite the ASX200 falling some 9% since June, these stocks are upwards of 5% off their six-month lows: the likes of Commonwealth Bank, AMP, ANZ, QBE, Brambles, Foster’s, Stockland, Woolworths, Woodside Petroleum, Rio Tinto and BHP Billiton.

In simple terms, I believe it means that our major stocks already bottomed some time ago and are now recovering and consolidating, despite the events of the past three months. Buy good stocks when they are down '¦ and hold them.

Michael Knox
Chief economist and director of strategy, ABN-Amro

Operating earnings per share for the S&P 500 have gone from $US15.22 in December to $US17.10 in June. Earnings are expected to improve further to $US19.97 in the September quarter.

Ed Prendergast
Portfolio manager, Pengana Capital

Yes, however the volatility and extreme events in the US this week remind us of the dangers of calling short-term market moves. Taking a medium-term view, we are confident the industrial sector has bottomed, with valuations at historic lows, and sentiment already very poor. Predicting an end to the bad news in the US is a brave call, but at some stage it will pass, and investors will return to fundamental, stock-specific analysis. Our domestic economy is in better shape than earlier feared; however this remains a key risk to the outlook should things worsen dramatically.

Steven Wright
Director, fixed interest, ABN-Amro Morgans

The Australian market has retraced almost 50% of its bull market gains. This rout will not continue indefinitely and will bounce once fear subsides and value is recognised.

Chris Caton
Chief economist, BT Financial Group

Last Thursday, the ASX200 closed one point below its mid-July level, which I had tentatively suggested may have been the low. On Monday, it spent most of the session below that low-water mark, but closed marginally above it. Financial-market ructions caused this and they won't go away quickly. Somewhere out there is a short-term rally, but the sharemarket will not get any traction until world growth prospects begin to improve. Look for more "bumping along the bottom"!

Lucinda Chan
Division director, Macquarie Private Wealth

Global markets have slumped severely in the past 24 hours, following Lehman Brothers filing for bankruptcy and the sale of Merrill Lynch to Bank of America. The world’s biggest insurer, AIG, fell some 58% after it was rumoured to be the next US financial firm facing the prospect of collapse.

To date, Australian companies have only felt limited direct effects of this crisis. It is impossible to quantify the asset values as balance sheets continued to come under pressure as funding costs rise. US banks are in a deep hole and the possibility of more banks joining the abyss is making investors very nervous.

Australia's banks are relatively sound but there is a wide differential between the best – Westpac and Commonwealth Bank – and the rest. Australia's economy is slowing but not heading for an overall recession, and is behind the US in timing of the slowdown.

China is expected to stimulate its economy later this year though falling demand from Europe will somewhat offset the impact. Australia had been protected by the Chinese growth machine and in the short-term, commodities market will remain volatile.

Craig James
Chief economist, CommSec

We can’t say for sure the market has not bottomed, given the ongoing instability in the US.

Saul Eslake
Chief economist, ANZ Banking Group

My scepticism that we had already seen the bottom of the equity market has been proved correct, although I take no pleasure in saying that. And I remain of the view that we still haven't seen the bottom, although in a perverse sort of way, the carnage of the past few days means that we're closer to that bottom than we were last week. The collapse of one or more over-extended financial intermediaries is an inevitable part of a crisis such as the one which began 14 months ago, and until it happened, the fear that it would was always going to be an obstacle to a market recovery. The market still has further weakness in front of it, since (as I've been stressing for weeks) it still hasn't factored in the implications (for corporate earnings and write-downs of other financial assets) of a US recession, which now looks more likely than it did to most folks a couple of weeks ago.

Roger Montgomery
Chairman, Clime Capital

No. In previous weeks I have said that any rally would be premature. It was. This is simple stuff: balance sheets need to be rebuilt or a new balance sheet needs to enter the fray to stabilise prices. The deleveraging (liquidation of assets) followed by liquidation of debt (selling of assets by banks who took possession) after 15 years of bingeing doesn't resolve in six months. It takes longer. Only when the equity side of the balance sheet is rebuilt will institutions, corporates and individuals gain sufficient confidence to warrant a sustained recovery in the stockmarket. In the absence of anyone else, what the US Treasury and Fed are doing is vital to avert a much more serious crisis.

Shane Oliver
Head of investment strategy and chief economist, AMP Capital Investors

No, shares are getting close to the bottom but the ongoing turmoil in the US financial system and the still deteriorating global economic and profit outlook suggests shares probably still have more downside over the next month or so.