The Markets:The year started badly and went downhill from there, with little sign of improvement in 2009, writes Proinsias O'Mahony

'BAILOUT" WAS Merriam-Webster's word of the year for 2008, so often was it looked up at the publisher's online dictionary. Other contenders included "precipice", "trepidation" and "turmoil", which pretty much sums up the type of year it has been for financial markets.

The year began in miserable fashion, with January seeing global indices pummelled on grim US economic data.

By March, financials were in freefall and concerns regarding the liquidity situation of investment bank Bear Stearns, which was facing massive losses due to its exposure to ailing mortgage-backed securities, led to a massive bank run.

The US government, fearful that a Bear bankruptcy would trigger a domino effect in the financial sector, agreed to sponsor a JP Morgan-backed rescue deal.

A "sucker's rally" ensued, with markets choosing to greet Bear's demise as likely marking some kind of climactic bottom.

Financial chief executives agreed, with one after another assuring investors in the months that followed that "the worst is over us". It wasn't.

Sub-prime related write-downs continued to mount, topping $500 billion by August. Increasingly desperate government efforts, including a $200 billion bailout of mortgage giants Fannie Mae and Freddie Mac, failed to stem the bleeding.

Speculation regarding the health of Lehman Brothers, a bigger investment bank than Bear and similarly exposed to toxic assets, continued to dog markets.

Failed takeover talks led to Lehman's share price cratering in September. A frantic round of weekend negotiations ensued, with federal authorities and the leaders of some of the world's biggest banks hoping that bankruptcy could be avoided. In the end, the extent of Lehman's toxic assets meant that no bank was willing to touch it.

The largest bankruptcy in US history, the fact that Lehman was allowed to fail stunned markets. Inter-bank lending dried up, with the London Interbank Overnight Rate (Libor) hitting record highs. Commercial paper markets froze and even healthy, credit-worthy firms were unable to secure short-term loans.

Just days after Lehman's failure, the US government prevented an even bigger bankruptcy, lending $85 billion to insurance giant AIG (by the end of the year, the AIG bill had risen to over $150 billion).

The contagion spread to Europe - Belgium, Luxembourg and the Netherlands rescued Fortis; Denmark bailed out Ebh Bank; Iceland took over Glitnir, the country's third-biggest bank; Britain's Bradford Bingley was nationalised; while Germany gave a €35 billion guarantee to protect Hypo Real Estate, with many blaming Depfa, Hypo's Irish subsidiary, for the property lender's problems.

US authorities soon announced a $700 billion programme to buy back the banks' toxic assets only to change its mind and instead use the money for the purposes of financial recapitalisation.

Markets rallied into the close of the year on foot of yet another financial rescue - this time Citigroup - but with volatility hitting all-time highs, continued financial uncertainty, bankruptcy fears for America's biggest carmakers and the world's biggest economies mired in recession, investors remain nervous.

Despite the late rally, global markets still suffered their worst year since the 1930s. There was no safe haven for investors - the commodity bust was even larger than the stock market crash, with oil tumbling from a peak of $147 in July to the mid-$30s in December.

The chronic international situation was magnified in Ireland, with the Irish market suffering its worst year since records began in 1782.

Disappointing data from Bapineuzumab, Elan's much- hyped Alzheimer drug, coupled with renewed safety concerns regarding Tysabri, its multiple sclerosis treatment, saw shares in the firm fall by over 80 per cent since July, thereby losing its status as Ireland's largest company by market capitalisation.

That honour now belongs to CRH, which represented 30 per cent of the Iseq by December.

Elan's fall was but a footnote in the Iseq's annus horribilis, however - the ailing fortunes of the country's four listed banks hogging the headlines. The financial index lost more than 90 per cent of its value and only the unprecedented Government guarantee of all bank debt saved at least one bank from going to the wall.

That solved the immediate liquidity concerns and sparked a brief price pop but it did nothing to address the looming hole in bank balance sheets.

It remains to be seen whether the recapitalisation plan announced just before Christmas is enough to restore a measure of confidence in the sector and the broader market.

THE FINANCIAL landscape at the beginning of 2009, then, is a fundamentally altered one. America's investment banking model is dead, with Bear Stearns and Lehman in the graveyard, Merrill Lynch taken over and Goldman Sachs and Morgan Stanley now commercial banks.

Credit losses and write-downs topped $1 trillion in December and 2009 is likely to see that figure mount.

This year, 2008, was also seen by many as the year that marked a decisive move away from the free market ideology that has prevailed over the last three decades, with many joking that the Bush administration entered office as social conservatives and left as conservative socialists.

It is estimated that the US government has spent $8 trillion bailing out financial institutions - an incredible figure given that the US spent $3.6 trillion in today's terms during the second World War.

Financials face much-increased regulation in the future while Keynesian economics is back in fashion as governments the world over launch large fiscal stimulus plans. Barack Obama's two-year fiscal stimulus plan is thought to be nearing the $1 trillion mark.

Whether large-scale government intervention can prevent the world entering an economic depression remains to be seen. The first global recession since 1982 is thought to be a given, with the OECD, the World Bank and analysts the world over predicting as much for 2009.

Harvard professor and former IMF chief economist Kenneth Rogoff, who correctly predicted large-scale bank failure this year, says: "We're going to face a deep downturn and slow recovery no matter what we do."

The challenge, he says, is "to contain it to a couple of years and not a decade".

World Bank chief economist Justin Lin concurs, saying that the world is facing "the worst recession since the Great Depression".

Mohammed El-Erian, joint chief executive of Pimco, the world's biggest bond fund, said the global economy suffered "cardiac arrest" in 2008 and "the most central banks and governments can hope" for may be to "stop the deterioration and set the stage for recovery in 2010". Failure "may heighten the danger of deflation and near-depression".

Merrill Lynch is slightly less pessimistic in its 2009 outlook. "Differences to the Great Depression are too many to take any comparison seriously," it says. Then, central banks reduced rather than increased money supply and thousands of banks were allowed to fail.

"Aggressive" policy response means that a lost decade à la Japan in the 1990s is also unlikely. "Fourteen years of Japanese experience have been replicated over 18 months," Merrill says.

In fact, most analysts see equity gains. Strategists at Deutsche Bank and Credit Suisse see European stocks gaining at least 20 per cent while the average American analyst envisages similar gains for the SP 500, the argument being that markets have already priced in global recession.

Investors aren't jumping for joy, however, given that analysts also imagined strong gains in 2008.

One near certainty for 2009 is that analyst earnings estimates will be sharply reduced. Despite being slashed in recent weeks, earnings growth of 14 per cent is still predicted.

Zacks Dirk Van Dijk describes such numbers as "borderline delusional", adding that price- earnings ratios "based on 2009 estimates will prove to be too low". Actual results have been an average of 11 per cent lower than estimates over the last five quarters.

Next year, 2009, is set to see continued financial deleveraging, with a recent survey finding that hedge funds are just over half way through the process of selling off assets. Global interest rates are expected to continue falling, with Bloxham Stockbrokers predicting possible "record lows" this year.

Despite the economic misery, many value investors say that equities are cheap for the first time in decades. Renowned fund manager Jeremy Grantham, who predicted financial carnage in 2007, sees promising gains for investors over the next decade.

He cautions that cheap stocks can get cheaper, however, especially in such an environment.

For 2009, Grantham predicted: "The period of heroic volatility will end pretty soon and will be replaced by a rather 1974-ish environment, where you quietly get bitterly resigned to your steady diet of bad news."