Cliff Taylor: Fears of a ‘nasty surprise’ lurking ahead for markets

Is there a big sell-off coming up in the markets before this is over? Not that what we have seen so far isn’t serious, with the ISEQ index of Irish shares down more than 19 per cent from its peak of early December last year. But taking a long-term view, shares are still well ahead of where they were a few years ago. With fears in the market of a “nasty surprise” lurking out there – possibly in the banking or financial sector – market sources in Dublin warn that there is scope there for more blood on the floor before this is over.

Market wobbles

Nobody knows, of course, and as the old saying goes, it takes two views to make a market. The yield on many bigger stocks is now starting to look attractive for investors. For the last couple of years equity markets have more or less ignored risks of a slowdown in world growth – apart from a market’s wobble last summer, the real trouble only started this year.

Markets often seem to use the flow of news to reinforce the mood of the moment; for most of last year growth fears were shrugged off with reassurance that central banks would save the day, while now every poor figure is used as an excuse to sell. And in the last few days the nerves have deepened.

The focus in the last few days has been the financial sector. There are well- aired fears about the impact of low growth and low interest rates on bank profitability. However lurking in the background are concerns that a couple of banks or financial institutions are in real trouble. “ The market is wondering is there a new Long-Term Capital Management out there”, said one market source, referring to the 1998 collapse and rescue of the hedge fund, which threatened huge instability in the financial sector. Markets are asking, for example, what will become of banking exposures to the energy and commodity sectors and whether this could lead to trouble for some lenders.

Deutsche bank “rock solid”

Notably on Tuesday, Deutsche Bank management was forced to confirm that its finances were “ rock solid”, with German finance minister Wolfgang Schäuble rowing in.There are specific factors hitting sentiment towards the German bank – notably litigation threats and a difficult restructuring – but it is also caught up in the global fears hitting the financial sector. Unfortunately for Deutsche, while there doesn’t seem to be any real evidence to contradict what its management are saying, investors treat bank bosses’ reassurances about their balance sheets in the same way as football fans interpret the board’s comment that it has “ full confidence in the manager.”

So like all banks, the price of Deutsche’s shares and of its other financial instruments are taking a heavy hit, as investors worry about what lies ahead and its ability to repay borrowings.

Nor is Ireland immune. Early in the year, the ISEQ index seemed to escape the worst of the hit, but now it is suffering along with the rest, and Bank of Ireland shares have been hit hard. Prospects for the AIB float have been clouded. And Ireland’s government debt has fallen back, hit by a general move out of peripheral markets and into rock solid German and US debt and also some pre-election jitters. Our 10-year interest rates are still very low at 1.08 per cent, but that is up from just under 1 per cent early on Monday and it will be interesting to see what the NTMA pays for €1 billion in 10-year borrowings being raised on Thursday

The market trend is bad, with every rally in equity markets quickly knocked on the head.There may be more selling to be done before this is over.