CIP INVESTMENT MARKET COMMENTARY
Prepared by Katrina Hawker, Capital Investment Planning Ltd

The month of January proved to be one of the worst starts ever seen for share markets around the world. The MSCI World (USD) index was down by 7.7% in January, the NZSX 50 was down 9.2% and the Australian All Ordinaries fell by 11.3%. Europe fared worst with the MSCI Europe ex UK (EUR) down by 12.3% for the month.

Where do the markets go from here? Well, that is dependent on a variety of factors, the main one being the likelihood of a US recession. Also in the mix are issues around the sub-prime - global credit crisis (worse to come or improving) and market sentiment (do you feel like investing now or waiting for further developments?).

Let’s have a brief look at these factors. Many economists and market commentators are now firm in their belief that the US is already in recession and whether they are right or wrong remains to be seen. We will not know if the US has had two consecutive negative quarters until they have happened. The general feeling seems to be that if a recession hasn’t already started then it will occur next quarter. What is possibly more interesting is the data on the impact of the Fed’s interest rate cuts on the US’s rate of GDP growth.

As can be seen from the chart below, the Fed’s own model and the IMF’s model both show similar impacts. The impact from a cut of 100 basis points (1.00%) in the Fed rates (the Fed cut 125bps in January) is GDP growth of 0.2% to 0.3% in the first quarter after the cut then increasing to 0.8% or more in quarters 4 to 6 after that.

Add to this President Bush’s USD 170 Billion fiscal package and the economic stimulus in place in the USA is substantial.

But is it enough to stop a recession? Our view is that it will have to be a very severe recession to last more than 2 or 3 quarters, given the extent of the moves made to date.

This leads to the other factors: sub-prime and global credit crisis. There is a huge amount of written material already on this subject and we are unable to discuss it fully here. A lot will depend on the next round of quarterly results from the major banks. These are likely to give us a better idea of the state of the credit markets. A NZ domiciled manager, Brook Asset Management Limited, recently talked about the extent of bank write downs. As at the 24th of January, these had amounted to USD124.8 Billion.

Market commentators and the Press seem divided over whether there is more to come or the worst has passed. To further illustrate the extent of the problem, at the end of January, Standard and Poors placed “on watch” or “downgraded” close to USD 1 Trillion in debt instruments. Telephone numbers that do exist!! Fitch Ratings have, in February, also been downgrading large tranches of debt instruments. Interestingly, of the Standard and Poors downgrades, about half were in Residential Mortgage Backed Securities and this was only for mortgage instruments issued in 2006 and early 2007. Potentially 2002 to 2005 are yet to be downgraded, or perhaps these are less problematic.

The Banks, of course, now have to re-price all the downgraded instruments and then report on the new pricing in the next quarter’s results. This implies further large write-downs. If the banks have already written down these holdings below the new pricing then their results will be fine with minimal further losses. As mentioned, the next result season will give us a clearer picture.

And finally, market sentiment. Currently, most sentiment seems to either be to “sell” or “hold” but not “buy”. (Actually, this is the time to buy, in our view, but by dollar cost averaging over a period of months.) The markets are going to be volatile for some time, at least until more information is available about the extent of the sub-prime global credit crisis. The possibility of a US recession will also impact on markets.

A cautious approach to investing is called for at this time. Market timing is nearly impossible to get right but, taking a long term investment view, downturns are nearly always a good time to invest. As prices get lower, more can be bought. Those cheap investments will, over time, result in enhanced returns when performance returns.