THE INVESTOR'S VIEW/Croesus:The early days of October have witnessed somewhat calmer conditions in the financial markets. Talk of bid interest in the beleaguered Northern Rock has been one factor that has helped the banking sector in the UK and Europe. This recovery has spilled over to the domestic market where, for once, the Irish banks outperformed their international peers. For Northern Rock shareholders, however, the news is not so good as any deal is expected to be done at a price that puts a very low valuation on the business.
A review of the performance of global markets and sectors for the first three-quarters of the year provides some interesting insights. From an Irish perspective, the most striking feature of the return data in Table 1 is just how badly the Iseq has performed this year with a decline of 16.2 per cent to end-September.
However, an American or European looking at returns will see a reasonably benign picture. In local currency terms the S&P500 is up 7.7 per cent, the FTSE Eurofirst300 is up 4.5 per cent and the FTSE100 is up 4.0 per cent. In fact, a number of the major equity indices such as the DJIA are at or very close to all-time highs.
Therefore, there is little sign of severe market stress in equity markets. Likewise, the prices of high-risk bonds issued by emerging market countries have not suffered declines of any substance during this summer's credit crisis. In fact, at a global level only two sectors - banking and construction/property sectors - have suffered badly.
With the benefit of hindsight a key signal of impending stress in the banking system was the rise in interbank rates of interest over the summer months.
Table 2 shows that at end-June three-month $ LIBOR, which is considered to be the benchmark wholesale rate, was just 11 basis points higher than the official rate of 5.25 per cent. The gap for € LIBOR was just 17 basis points. The gap for £ LIBOR was somewhat higher at 50 basis points although this reflected expectations that the UK repo rate was about to rise, which it subsequently did on July 5th to 5.75 per cent.
By end of August the picture had changed dramatically with € Libor 75 basis points above the ECB repo rate while in the UK the gap had risen to within a whisker of a full percentage point. Despite repeated large injections of central bank liquidity into the system, three-month money is still trading at stubbornly high levels. From the perspective of the Irish banks, it is particularly worrying that three-month € LIBOR is trading at 4.79 per cent compared with the 4 per cent repo rate.
If this situation persists it will put a severe squeeze on banking profits going forward. It is not surprising, therefore, to find that the banking sector has been one of the worst performing sectors across all equity markets. To end-September the FTSE E300 bank sector is down 9.4 per cent while the US S&P500 bank sector is down 18.6 per cent. This compares with a decline of 23.5 per cent in the Iseq Financial index over the same period.
The other global sector to suffer across the board this year is construction and property.
The total capitalisation of the Irish equity market is about €105 billion. The four large Irish financial stocks together with CRH have a combined market capitalisation of about €56 billion.
So banking and construction-related stocks account for about 60 per cent of the total Iseq market capitalisation. This is a far higher concentration in these sectors than is the case for the major international equity indices. Possibly as much as half the relative underperformance of the Irish equity market is due to its peculiar sectoral composition.
