Ups and downs

Another 0.25 percentage point interest rate cut gave markets a lift in early November, but no sooner had this been announced then bad news from the banking sector took what steam there was out of the rally. Write-downs on bad loans by Credit Suisse and investor downgrades for Citigroup and Bank of America damaged confidence in the stock market as a whole.

The feeling seems to be that while the sub-prime credit crisis may not be having a huge impact on the real economy, the banking sector still has not got all of its skeletons out of the closet. This will impact on profitability this year and may lead to lower dividends, asset sales, capital increases and other things that upset investors by lowering share prices. There may also be more bad news to come in year-end financials.

Another problem that has grown over the autumn has been the rising price of oil. Low inventories and the approach of winter have seen the price creep up and threaten the $100 per barrel mark. The cost of oil is at an all-time high, both in nominal terms, and in inflation adjusted real terms, which is to say it is above the level seen in the energy crises of 20 to 30 years ago.

But this is not to say we're looking at a damaging recession along the lines of the early 1980s downturn. One reason is that there is less manufacturing in America now compared to 1980, and what there is, is more energy efficient. This means high oil prices have less of an impact on industry. Also, on the consumer side, people have more disposable income now than they did 25 years ago, so high gas and heating prices make less of a dent in overall household incomes.

The other factors that contributed to the 1980s recession – high inflation, unemployment, tight monetary policy and sky-high interest rates – are also much smaller issues today.

Market reaction

The price of oil is still a problem, of course, and the stock market fall of mid October coincided with oil going above $90 per barrel and staying there. As our graph shows, the September-October rally tapered off quite steeply in early November as oil prices rose and the banking sector disappointed. Just prior to this the ACT HEI had hit a record high of 197.16 points, eclipsing the previous record of 195.05 set on July 19, just prior to the sub-prime crunch.

But, as third quarter results showed, the real economy remains robust. There may be problems in residential building, but many heavy equipment companies said at the end of December that the slowdown in the US was more than compensated for by growth in every other part of the world. Indeed, the crane sector is still seeing order backlogs get longer rather than shorter.

So, while niggles from the summer's credit crunch and the price of oil continue to undermine optimism on the stock markets, the outlook is still positive.