Market forces

CROESUS:They say that a week is a long time in politics but one day must have seemed too long to many market participants given the volatility in equity and credit markets over the past two weeks.

At its worst, the Iseq was off 17 per cent from its February high and 12 per cent down on its end-December level.

Healthy year-to-date gains in many overseas markets had been severely eroded by Monday of this week, or in the case of the FTSE 100, had been completely wiped out.

However, just when the media pundits were at their gloomiest, a rally that began on Monday in the US gathered steam on Tuesday with some of the hardest-hit markets such as the Iseq bouncing the most.

Tuesday's 308-point gain on the Iseq was the index's largest daily point gain, although the impressive 3.7 per cent gain was far from a daily record. In Britain, the FTSE 100 rose by 2.5 per cent on Tuesday to bring its year-to-date performance back into positive territory.

A refocusing on economic reports and corporate financial statements was the catalyst for this mini-rally.

In the US, good news on inflation and some good reports on company earnings were well received by the markets. The core personal consumption price index rose by 1.9 per cent over the past year, which was the lowest inflation rate in three years and just within the Fed's unofficial comfort zone of 1 per cent to 2 per cent for core inflation.

Some good earnings reports from corporate giants such as General Motors provided a further positive fillip to investor sentiment in the US equity market. European and Asian markets followed suit as the feeling grew that perhaps worries about a contraction in the availability of credit had become overdone.

This improvement in sentiment proved to be short- lived when late on Tuesday, American Home Mortgage Investment Corp, the 10th largest mortgage lender in the US, stated that its lenders had initiated margin calls because the loans and securities the company was holding as collateral to back its borrowing had dropped in value.

The company said it had already paid substantial margin calls over the past three weeks but it was unable to fund obligations of $300 million (€219 million) on Monday and up to a further $500 million on Tuesday.

With bankruptcy staring it in the face, American Home would be the first big lender outside the sub-prime sector to go bust.

Not surprisingly, European markets opened lower on Wednesday in response to the weaker close on Wall Street and relinquished a big part of the previous day's gains.

Until the extent of the crisis in the US clarifies, volatility is going to remain very high in both credit and equity markets. Meanwhile, a high percentage of financial results from corporates continue to be very healthy.

Two of the Irish markets largest companies, AIB and Ryanair, reported positive results during the week. In contrast, drinks group C&C issued another profits warning on Tuesday.

However, unlike AIB, developments in C&C have no implications for the broader economy or market. The bad summer, particularly in Britain, and tougher competition led to a collapse in cider volumes.

AIB's first-half 2007 results were slightly better than market expectations with earnings per share of 108.8 cents which was 16.6 per cent up year-on-year, compared with brokers' forecasts of approximately 106 cents.

As expected, the interim dividend got an uplift of 10 per cent. Looking behind the headline numbers reveals that the credit quality of AIB's loan book is exceptionally strong.

Non-performing loans as a percentage of assets declined to 0.7 per cent from 0.9 per cent in December 2006. At its post- results presentation, AIB was very positive on the outlook for its business in Ireland.

Its broad mix of business leaves it well positioned to cope with the slowdown in the Irish construction sector and mortgage market.

Meanwhile Ryanair's share price bounced sharply in reaction to its better-than- expected first-quarter (to end June) earnings report.

Average fares during the quarter declined by a marginal 0.5 per cent against expectations for a much steeper fall. Ancillary revenues were much better than expected increasing by 29.3 per cent to €9.29 per passenger and by 53 per cent to €117 million at a total level.

Unit costs increased by a faster-than-expected 5.4 per cent due to staff cost and airport charge increases. The company raised its guidance for profit growth in 2008 to 10 per cent from 5 per cent.

The big uncertainty remains the outlook for the winter months when demand is expected to be very price sensitive. Reflecting this uncertainty, Ryanair reported that it would be reducing capacity at Stansted this winter, from 40 aircraft to 33, as airport charges levied are rendering some routes uneconomical.

While good corporate results on their own provide some support to equity markets, they are not sufficient on their own to spur a market rally.

For the Irish market, a meaningful rally will need both an improvement in international investor sentiment and greater clarity regarding the extent of the expected 2008 economic slowdown.