By Tony Jackson
December 9 2007
SourceAs the credit crisis deepens, at least one big question has been answered. We now have abundant evidence that the crisis is affecting the real economy. So we need to switch our attention from the travails of the banks and look instead at their customers. Which of them are getting hit?
The benign response comes from the global economics team at Merrill Lynch. Granted, they say, US mortgage borrowers are suffering and their UK counterparts will be shortly.
But in the eurozone, consumers are less heavily indebted. And credit creation in the eurozone, on the latest October figures, is still showing strong double-digit growth.
Hence the fact that the European Central Bank did not cut interest rates last week. It saw no need.
Asia, meanwhile, is awash with savings, and so is unaffected. And across the world, corporate balance sheets are strong and governments are under no particular pressure to borrow. So by a process of elimination, the victims of the crisis are Anglo-Saxon consumers.
One way of testing that is to look at the stock prices of companies that make their living from supplying those consumers. But before we get to that, let us examine the Merrill thesis further.
It rests heavily on the premise of so-called “decoupling” – the ability of China, in particular, to shrug off a US slowdown. That is the next big unanswered question, and not everyone agrees with Merrill.
The Merrill case is that the rise in Chinese imports to the US in recent years has been vastly greater than the US growth rate and has been apparently unaffected by variations in that growth.
So a point or two off US growth next year is neither here nor there. Opponents of that view argue that the more China is integrated in the world economy, the less immune it becomes to external shocks.
I am not about to settle that argument here. But in the absence of hard data, let us turn to the markets. Investors may be wrong – indeed, they often are – but in situations like this their views represent information of sorts.
Equity investors, at least, lean to the Merrill side of the argument. Among consumer stocks, there has been a clear and familiar distinction between discretionary purchases and staples. In the UK, for instance, general retailers’ shares are down 16 per cent since the debt crisis began in August and the leisure sector is down by a similar amount.
However, food retailers – the classic defensive play – are up some 10 per cent. The US picture is similar, with consumer discretionary stocks down 7 per cent over the period and consumer staples up 10 per cent.
Industrials are another matter. Across Europe, the auto sector is up 34 per cent this year and steel by 28 per cent. Mining is up 50 per cent. In other words, equity investors buy the decoupling argument, and believe European manufacturers will be able to make good any shortfall in US demand. If they are wrong about that, the results could be painful.
But it is also worth a glance at the credit markets. Here, the position is rather less clear cut, as shown by the behaviour of credit default swaps, which represent the cost of insuring against default.
Since the crisis took another turn for the worse some five weeks ago, according to the data collection firm Markit, the average cost of insuring against default by consumer goods companies has risen globally by 70 per cent.
The cost for industrials, on the other hand, has risen 50 per cent, and for basic materials – in effect, mining – 55 per cent. To put that in context, the most defensive sector, healthcare, is up 25 per cent, while at the other extreme, financials are up 95 per cent.
It is worth pointing out that the equity and credit markets do not always measure the same things.
A highly leveraged bid, for instance, will hit the target’s CDS, while lifting the stock price. But leveraged bids are off the agenda for now. It really does look as if the two markets are telling a different story.
To that extent, our opening question seems still to belong in the unanswered category. The pain being felt by Anglo-Saxon consumers is not in doubt. It is not yet clear that it stops there.
The other unanswered question, after all, is how long the credit crisis will last. The consensus seems to be until next summer. But that seems mainly based on forward interest rates, next summer being the point at which official rates and the London interbank offered rate come back into line.
And since that is merely investor opinion in another form, the argument is somewhat circular. We know the crisis is getting worse. We delude ourselves if we think we know much else.
tony.jackson@ft.comCopyright The Financial Times Limited 2007