Friday, July 08, 2005

London blasts - Summarizing the risks for the US equity markets...

Before the open, it looked as if the US indices would have steep losses during the day, with S&P futures indicated down 17 points before the open. At close, all the three indices (S&P, DOW, Nasdaq) were up. One would have expected that with oil still at $60 and Hurricane Dennis building up in the Atlantic, the blasts would cause the S&P to have double digit losses and the DOW to have triple digit losses. That was however, not the case.

This resilience by the US markets in the wake of terrorist attacks might indicate that the underlying fundamentals are stronger than thought (by me). Or maybe, there is too much money in the world chasing too few investment opportunities, which jumps at any asset that falls in value. So I thought it would be instructuve to prepare a list of the biggest risk factors that might cause the the US equity markets to move down:

1) Slowing year-on-year earnings growth due to higher 2004 base.
2) Historically high profit margins for corporates - Reversion to the mean would lead to lower profits
3) Market trading at around its long term average of 15-16x (I need to figure out exactly how much, as even a 1x multiple swing indicates 6% swing in values)
4) Interest rate tigheting by Fed, and the narrowing yield curve. Inverted yield curve has historically been a harbinger of depression, though Greenspan thinks that is not the case this time.
5) Huge US budget and trade deficits - with associated long-term implications of dollar weakening
6) Oil prices at $60
7) Housing bubble - the current economic expansion has largely been driven by consumer spending, which in turn has been driven by higher income effect due to appreciation in home values. If the housing market to have a sharp correction, things could become ugly for the broader market.
8) (Now) Terror Risk

Separately, Bank of England kept its benchmark rate unchanged at 4.75%. With Euro weaker to dollar since the beginning of year, some investors have been predicting that the European banks don't need to cut rates to spur growth on the continent. Maybe that is what the Bank of England thought. I should look at the minutes of the meeting when they come out.

Also of news of personal interest, Deutsche Bank decided to sell part of its asset management business, after Citigroup got out of CAM a couple of weeks back by selling it to Legg Mason. Guess it is not a good idea to be employed by an asset management business owned by an investment bank. Lets see what happens to Morgan Asset Management and Merrill Asset Management, Goldman seems to be doing great in its asset management business.

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