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Stock markets are finally correcting

Stock markets are finally correcting
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First Published: Thu, Jan 17 2008. 11 17 PM IST
Updated: Thu, Jan 17 2008. 11 17 PM IST
The 2007 puzzle of stock market performance is being resolved. The mystery was how well equities resisted increasingly severe problems in the credit markets and significant signs of slowing economic growth. Most indexes in the US and Europe were up for the year.
The answer, it seems, was that it took time for stock market investors to realize how bad things really are. They have now caught on. In January, markets have fallen by about 10% in Europe and the US—enough to wipe out all the previous year’s gains.
Tuesday was a particularly bad day in the US. In the morning, investors had to swallow higher loan losses from Citigroup Inc.—a sign of a weak US economy and news that retail sales were disappointing in December.
The Standard and Poor’s (S&P) 500 index of US stocks fell by 2.2% on Tuesday to 1380.95, bringing its decline in 2008 to 5.9% %. As of Wednesday afternoon, it was at 1379.57—down 2.7 % from the beginning of 2007.
The Dow Jones Euro Stoxx 50 index rose by 6.6% in 2007. Since the beginning of 2008, it has fallen by 6.9%.
The FTSE 100, a share index of the 100 most highly capitalized companies listed on the London Stock Exchange, was trading at 5908.50 on Wednesday—the lowest level since August. More bad days are likely in the next few months, as the problems of the housing and financial sectors spread through the rest of the economy.
But even if the US avoids a recession, there are three reasons to think US profits are likely to be under pressure.
First, wider credit spreads will push a higher proportion of operating cash to lenders, leaving a smaller portion for shareholders. Second, tighter credit conditions will make companies reluctant to buy back shares—a big source of reported earnings per share growth in recent years.
Finally, with US consumer price inflation at 4.1% in 2007— the highest level in 17 years—workers may strive especially hard for profit-denting wage increases. The rest of the world should not suffer too much from US problems. But growth is slowing in Europe and higher inflation seems to be a global phenomenon.
And the same financial globalization which has helped stock markets rise in unison could well bring them down together. It would be comforting to hear that markets are cheap, even if they are falling. But they aren’t.
US stocks are selling at 14 times expected 2008 earnings, well above the long-term average of 12, according to Société Générale research. The best hope for stocks is that, with inflation on the rise, they may do better than bonds. But that’s not saying much.
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First Published: Thu, Jan 17 2008. 11 17 PM IST
More Topics: Stock | Markets | Money Matters | Equities |