Why the market turmoil is far from over

Even by this year’s volatile standards, yesterday was a horrendous day for global stock markets. The FTSE had its worst day since the big credit squeeze in August and the Dow slumped below 13,000. So what happened?

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Even by this year's volatile standards, yesterday was a horrendous day for global stock markets.

The FTSE 100 had its worst day since the big credit squeeze in August, diving 2.7% to 6,120.8 - it's now below where it started 2007. Across the Atlantic, meanwhile, the Dow Jones Industrial Average shed 1.7%, falling to 12,958.

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So what happened?

As regular readers might suspect, the latest bout of panic in the stock markets was another symptom of the credit crunch. The blame for this particular episode is being laid at the feet of investment bank Goldman Sachs (GS). Not because Goldman has issued a write-down - but because its analysts have warned that other banks are heading for more trouble.

In a research note, Goldman's team said that it believes the fall-out from the subprime crisis will still be hurting the financial sector at this time next year. Goldman reckons Citigroup (C) will suffer another $22bn write-off - $11bn for the current (fourth) quarter, and another $11bn throughout 2008. Merrill Lynch (MER) will have to write off another $13bn, and Morgan Stanley (MS) $8bn.

Michael Vaknin, a Goldman economist, said that as long as the banks were continuing to mark their assets to market (in other words, finding out what someone's actually willing to pay for an asset, rather than just whatever the bank's analysts guess it's worth), then "financial skeletons will likely keep popping up here and there, exerting further pain on markets."

Of course, it wasn't all down to one broker note. Reinsurance giant Swiss Re warned that it will have to write off £525m on credit default swap (CDS) losses (a CDS is basically a derivative that allows you to bet on - or hedge against - the likelihood of a company going bankrupt or defaulting on its debt in some way), linked to portfolios of mortgages.

The big worry is that while Swiss Re is insisting this is it as far as its exposure is concerned what problems are other insurers going to face? This is the first real sign of the sub-prime pain moving out from the banking sector, and insurance shares fell across the board.

Perhaps more importantly, banks are still feeling paranoid not surprising, given Northern Rock's (NRK) travails. The three-month interbank sterling lending rate rose for the seventh session in a row to its highest level since September 19th. Meanwhile carry trades unwound, sending the Swiss franc to a fresh 12-year high against the dollar. The yen also made gains (incidentally, you can find out why the yen and the Swiss franc are among Jim Rogers' favoured currencies in this week's MoneyWeek cover story: Latest Issue). If you're not a subscriber, then you can sign up here for three free issues).

But it's not just the financial sector of course. Out there in the real world, people are hurting too particularly Americans. Lowe's (LOW), America's second-largest home improvement group, warned on profits for the second time in two months. It warned that earnings for the quarter to February will be lower than expected, as the housing market continues to deteriorate.

Against this backdrop, you might not need persuading that now is not the time to buy banking stocks. But just in case - there's a very good piece in the FT this morning which explains exactly why now's not the time to buy banks, despite their hefty dividend yields and single-digit p/es. Sure they look tempting but here's why you should give them a miss: Banks hide a sting in the tail



And just another reminder - a collection of the best bits from MoneyWeek's Bottom Line' column, called "How Much?!" is out now. Stuffed full of amusing and scandalous financial trivia, it's the ideal stocking filler. Money Morning readers can get it at a discount by entering the promotional code MoneyW when placing their orders. Click here to order your copy now: How Much?!

Turning to the wider markets

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In London, the FTSE 100 closed 170 points lower on Monday, at 6,120, as stocks fell across the board. Northern Rock led the banking sector lower with a share price plunge of over 21% after it became clear that all Friday's bids for the bank were below market value. Real estate stocks including Land Securities and British Land also fell heavily on concerns over the property market. For a full market report, see: London market close.

Elsewhere in Europe, shares also ended the day lower on investor unease as to the economic outlook. In Paris, the CAC-40 fell 91 points to close at 5,432. And in Frankfurt, the DAX-30 was 100 points lower, at 7,511.

On Wall Street, Goldman Sachs's pronouncements saw US stocks tumble yesterday. The Dow Jones fell below the 13,000 mark for the first time since August, shedding 218 points overall to end the day at 12,958. The tech-rich Nasdaq was 43 points lower, at 2,593. And the S&P 500 fell 25 points to close at 1,433.

In Asia, M&A news plus positive comments from the Fed on the economic outlook for the US saw Asian stocks end the session in positive territory. The Japanese Nikkei closed 168 points higher, at 15,211, having earlier hit a low of 14,751. And in Hong Kong, the Hang Seng pulled back from a low of 26,404 to end the session 311 points in the black, at 27,771.

Crude oil had extended yesterday's moderate gains this morning, and was trading 56c higher - at $95.20 - in New York. And in London, Brent spot was at $92.70.

Spot gold was hovering near a three-week low today, having fallen to $774.90 before edging back up to $780.70. And silver was at $14.26.

In the currency markets, the pound was at 2.0611 against the dollar and 1.3964 against the euro this morning. And the dollar was at 0.6773 against the euro and 110.16 against the Japanese yen.

And in London this morning, shares in Paragon (PAG) - purveyor of buy-to-let mortgages - slumped a further 44%, having already fallen 70% so far this year on investor fears that, like Northern Rock, it would struggle to raise money in the wholesale credit markets. The lender announced that it may launch a £280m rights issue if it is unable to secure other funding by February.

Finally, our recommended articles for today...

Is the art mania coming to an end?

- Having just missed out on buying a light sculpture for £3,200 five years ago, Merryn Somerset Webb was shocked to discover that a similar work sold for £356,000 in August. Unfortunately, the days when buyers in the art market could expect such stratospheric gains are long gone. To find out why, like Damien Hirst's shark in a tank, the contemporary art market is past its best, click here: Is the art mania coming to an end?

Curbs on blood diamonds to be extended

- Ten years ago, the share of conflict diamonds in world output was as high as 10%. Now - thanks in part to the Kimberley Process and also to the spread of peace across Southern Africa - that number is less than 1%. For more on other recent developments in the diamond market, click here: Curbs on blood diamonds to be extended

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.