Is this crisis worse than LTCM?

Since their summer peaks, the FTSE 100 Index has fallen 7.7%, the FTSE 250 has fallen by 9.2% and the FTSE SmallCap is 9.7% lower. So far, the markets have been reacting to specific financial news related to debt markets rather than economic data and little attention has been given to corporate earnings which have been generally better than expected. Over the last year, the M&A boom has helped the UK market more than most and the FTSE 100 Index is 0.2% lower for the year to date compared to a 2.8% rise in the S&P 500 Index.

Normally, the real economy suffers little impact from a one-off financial event but recent woes pose more questions than answers largely because it is difficult to know the full extent of the financial losses. Nervousness is compounded by the size and importance of the financial services sector to the UK stock market and the UK economy e.g. Financials account for a 28% weighting in the FTSE All Share Index and the industry has been the biggest contributor to recent GDP growth. All it needs now is for falling US house prices to pass across the pond to add to the uncertainty. However, balanced against these concerns, there have been some large share price falls even in non-financial companies since 15th June and given the upward trend in corporate earnings, the valuation of equities looks attractive.

In the first half of 2007, UK equities were ticking along nicely i.e. the FTSE 100 Index was up over 6% but since hitting 6,732 on 15th June the Index has declined by 7.7%. The FTSE 250 peaked at 12,220 on 23rd May and has fallen 9.2% from its peak. The FTSE Small Cap reached a record high of 4,209 on 4th June and has fallen 9.7% since that date. At its worst, the FTSE 100 touched 5,859 down 13%. In terms of FTSE All Share sector performance, the tables below show the outcomes for the year to date (YTD) and since 15th June (15/06). Also, we produce a list of the top and worst performing FTSE 100 companies for the YTD and since 15/06.

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Normally, specific financial events have little impact on overall economic growth as in 1998 when a liquidity crisis caused by the Russian default and the collapse of the Long Term Capital Management fund caused fears of a meltdown which never appeared. So, in theory, our summer equity market correction provides an excellent buying opportunity! Alas, almost daily announcements regarding banks and hedge funds exposure to the US sub-prime mortgage market and other asset back securities have emerged across the globe e.g. Germany, France, China and Japan as well as the UK and US.

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It is estimated that up to 40,000 US jobs have been axed in the mortgage business as banks/brokers close or restructure their operations. More importantly, these financial issues stem from a key leading indicator of economic activity the housing market. In the US, the Federal Reserve acknowledged that the risks to growth have increased and a Federal Funds interest rate cut looks likely on 18th September. Although the Bank of England has remained calm and quiet during recent events, the European Central Bank stated that it is not "pre-committed" to an interest rate rise on 6th September.

No doubt, central banks will calm financial markets eventually with injections of liquidity or interest rate cuts. In recent days, there have been some positive developments for markets in the form of Bank of America investing $2bn in Countrywide Financial (leading US mortgage provider) and Home Depot finally sealed a deal to sell its Wholesale Division for $8.5bn, albeit at a lower price than the original $10bn anticipated. Nevertheless, the more important issue is the recession in the US housing market. House prices fell by 3.2% in Q2 according to the S&P/Case-Shiller US National Home Price Index. This data predates the recent financial turmoil and an extended period of falling house prices would have a major negative impact on consumer confidence.

Not surprisingly, within the UK equity market, the Bank sector is among the worst performers (-11%) and Real Estate which was already a weak sector has fallen another 10% since 15/06. General Retailers have been hit hard (-11.5%) as investors fear about the health of consumer spending as mortgage equity withdrawal begins to decline. Wolseley (high exposure to US housing) and Experian (provides credit services) have pulled back the Support Services sector (-10.5% since 15/06). In the Travel & Leisure sector (-10.8% since 15/06) the evaporation of takeover speculation and hiatus in corporate deals have hit Punch Taverns, Intercontinental Hotels and Mitchells & Butlers.

Mining stocks have been one of the best performing sectors YTD (+21%) and although the sector suffered from profit taking with a fall of 9% since 15/06, it has been largely driven by the problems at Lonmin (share price -27%) and a setback at Anglo American (-15%) and Rio Tinto (-15%). Three Mining stocks, BHP Billiton, Antofagasta and Vedanta have all shown gains of 5%, 12% and 6% respectively since 15/06. The Rexam share price has also bucked the trend on the back of reduced exposure to aluminium pricing. On the whole, despite the drag from a weak dollar, UK companies have reported pleasing Q2/H1 results and generally EPS estimates have firmed. Good results from British Aerospace and BSkyB boosted their share prices.

In summary, recent financial events look worse than in 1998 because of the widespread exposure among banks and hedge funds and deepening problems in the US housing market. Although large cap stocks have declined less than their smaller brethren, the losses if maintained could also be a negative factor on consumer confidence. However, the key driver of equity prices is the trend in corporate earnings and so far this remains encouragingly positive. Our tables below show some huge falls for some of the UK's largest companies and no doubt there are some bargains to be picked up (look at some of the worst performing FTSE 100 stocks since 15/06).

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Is this crisis worse than LTCM?

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Why it's worse this time

How FTSE sectors have performed

Worst Performing FTSE 100 Stocks

Best Performing FTSE 100 stocks

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Why it's worse this time

How FTSE sectors have performed

Worst Performing FTSE ALL SHARE SECTORS

Best Performing FTSE ALL SHARE SECTORS

Worst Performing FTSE 100 Stocks

Best Performing FTSE 100 stocks