The stock market sell-off gathered momentum today, with the Dow and S+P 500 plunging between 2.7% and 2.9% within the first 10 minutes of the open.
This came as escalating tensions between North and South Korea and the potential for a Spanish banking sector contagion revived risk aversion.
‘We’re back in uncharted territory,’ said Art Hogan of Jefferies Group. ‘Korea is a major distraction at a time of global uncertainty. The market is selling for a bigger reason. There’s concern about the banking industry in Europe.
The Libor rate has spiked, which certainly signifies that the credit is slowing in an interbank basis. The market is trying to price in the worst-case scenario right now, of not only lending freezing, but of a major bank becoming insolvent.’ [1]
We are unequivocally passing through a period of intense global uncertainty and banks are beginning to lose confidence among one another again – a phenomenon clearly visible following the collapse of Lehman Brothers in September 2008.
Unfortunately, the situation seems to be moving in that direction again. The dollar Libor-OIS spread is showing that banks are becoming more reluctant to lend to each other.
The gauge widened to 31.1 basis points from 28.4 basis points today, the most since July 17, and the London Interbank Offered Rate (LIBOR), the rate banks pay for three-month loans in dollars, rose for an 11th day to 0.536%. This is the highest level since July 7 and suggests that the financial institutions are beginning to question the creditworthiness of their peers.
The increasing level of unease in the global banking system is predominantly caused by the recent nationalisation of Spanish savings bank CajaSur. This left the market feeling as though this development may only be the tip of the iceberg and that a major relapse is in store for the European banking sector.
More importantly, however, the incident signals the region’s sovereign debt crisis beginning to engulf financial institutions.
Strains in Spain’s banking system are intensifying concern that the Greek debt crisis may spread, said Mohamed El-Erian of Pacific Investment Management Co (PIMCO), the world’s biggest bond fund.
‘Banks have a way of amplifying shocks in the system,’ El-Erian said in an interview last night. He added that banks are ‘like the oil in your car. They link up so many different parts. The minute you introduce strains in the banking system, there’s always a fear that governments will be behind the curve and that you can get contagion’, which would lead to ‘widespread disruption’. [2]
Unsurprisingly, banks were among the hardest hit sectors today, with Citigroup retreating 2.4% to $3.70, Bank of America down 2.4% to $15.03 and Wells Fargo losing 2.1% to $28.12.
Resource shares were predominantly in the red as well, with the likes of Freeport-McMoRan Copper & Gold, Southern Copper and Alcoa all down by around 2% this afternoon.
Gold shares bucked the negative trend, however, with Barrick Gold climbing 1.2% to $41.62, Goldcorp up 0.7% to 41.33 and Yamana Gold 0.8% higher at $10.19.
June gold, considered a currency of last resort, rose 0.4% to $1,198.6 per troy ounce, helped by safe-haven buying. July high-grade copper futures tumbled 3.8% to $3.0285 while July Light-sweet crude oil (WTI) declined 2.4% to $68.54 a barrel this afternoon following a mixed bag of US economic data.
Official figures released today showed that home prices in 20 US cities rose less than forecast in March from a year earlier, a sign the housing recovery is beginning to slowdown.
The S+P/Case-Shiller home-price index of property values in 20 cities increased 2.3% from March 2009, trailing expectations for a 2.5% increase
‘You probably did get some support to house prices from the credit, and as that wears off house prices may fall off a little bit,’ said Michael Feroli of JPMorgan Chase & Co. ‘We don’t expect house prices to pick up noticeably for a long time. If the recovery continues, I expect home sales to pick up with the labour market.’ [3]
Meanwhile, US consumer confidence surprised to the upside today, rising to 63.3, the highest level since March 2008, from 57.7 in April, as concerns about the US labour market continued to ease.
By 4pm (London time) the Dow Jones Industrial Average had pared earlier gains. The index was trading 172.31 points (-1.69%) lower at 10021.08, up from an earlier intra-day low of 9477.63.
In addition, the broader S+P 500 was trading at 1054.83, representing an 18.82-point (-1.75%) move from the prior day’s closing level.
From a valuation perspective, US indices are now trading below their four year average. The S&P 500’s historic price earnings ratio stood at 15.5x last night, below the 4 year average of 16.4x.
In addition, data compiled from Bloomberg shows that the S+P 500 traded at 13.2x on current year earnings estimates, lower than the 4 year average of 14.95x.
Source: [1][2][3] Bloomberg News ( 25 May 2010)
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'Spread Betting News 25 May 2010', Article by IG Index, last update: 25-May-10
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