World Indices Nosedive - U.S. Markets Could Follow

By , Money Morning •

By Jennifer Yousfi
Managing Editor

Trading yesterday in Europe and Asia was brutal. While the U.S. markets were closed in observance of Martin Luther King Day, global indices took tremendous one-day hits that plunged some past the 20% bear market indictor.

After the markets closed, U.S. futures contracts were pricing in a major decline for today and trading is likely to be harsh, with the possibility of a 500-point drop for the Dow Jones Industrial Average Index.

The blue-chip Dow, long seen as an indicator of the overall health of the financial markets, is already well past a 10% correction and sliding lower. On Friday, the Dow hit a new intraday low of 11,953.71, a 15.8% decline from its intraday peak of 14,198.83 on Oct. 9. A decline of 20% from a 12-month high indicates a bear market.

And yesterday's overseas turmoil might just be the last push the Dow needs to sink below that all-important 20% waterline.

Based on a combination of lackluster market performance last week, continued financial market troubles and skepticism over the Bush administration's proposed economic stimulus package, world markets dropped across the board. 

In Europe, Britain's benchmark FTSE-100 lost 5.5% to a 5,578.20 close; France's CAC-40 Index shed 6.8% to close at 4,744.15; and Germany's blue-chip DAX 30 plummeted 7.2% to a 6,790.19 close. Russia's Micex Index was down 7.5%, its largest decline since June 2006. Europe's Dow Jones Stoxx 600 Index dropped 4.1 percent, extending its loss from its June 1 peak to a bear market at 22%.

Asia fared much the same as India's benchmark stock index lost 7.4%, while Hong Kong's blue-chip Hang Seng Index dived 5.5% to 23,818.86, its biggest one-day percentage drop since the 9/11 attacks. Japan's benchmark Nikkei 225 index slumped 3.9% to a 13,325.94 close, its lowest level in two years. China's Shanghai Composite Index was down 5.1%, fueled by concerns about Chinese banks' exposure to U.S. subprime mortgage investments.

Even with the U.S. markets closed, the Americas did not escape the worldwide market rout as Canada's Toronto Stock Exchange-listed S&P/TSX composite index fell 4% while Mexico's benchmark IPC stock index declined 4.6%.  In South America's largest market, Sao Paulo, Brazil's Bovespa index slipped 6.9%.

The MSCI World Index slipped 3%, extending its decline from its Oct. 31 peak to 17%, while the MSCI Emerging Markets Index flirted with bear territory as it lost 5.4%, extending its loss from its October peak to 19.7%.

Continued Financial Market Woes

Once again, financial stocks lead the decline as beleaguered banks reported even more mortgage-backed security related write-downs were in the making.  

DJIA component, Citigroup Inc. (C) fell to its lowest level since 1998 on Friday. Shares fell $0.51 (2.04%) to close at $24.45. The cash-poor bank also sold $3.25 billion in preferred shares, Reuters reported.

French banks were hard hit after comments from Christian Noyer, governor of the Bank of France, appeared in the International Herald Tribune.

"I'm reasonably confident that French banks will weather this turmoil without major trouble even though they are clearly, like all banks, in the world still in the process of marking down assets," he said, signaling that despite billions of dollars in write-downs so far, more were still to come.

In Asia, investors worried over a potential $8 billion write-down of U.S. mortgage securities by Bank of China Ltd., The Wall Street Journal reported.

Equally troubling, top bond-insurers Ambac Financial Group Inc. (ABK) and MBIA Inc. (MBI) are in jeopardy of losing their AAA-ratings, which in effect would downgrade the ratings of the $2.4 trillion in securities they insure. The rating downgrade could result in forced sales by institutional investors who are restricted to holding only the highest-rated assets.

"The major risk for credit markets remains forced selling on the back of downgrades of the insurers," Jochen Felsenheimer, the Munich-based head of credit derivatives research at UniCredit SpA, Italy's biggest bank, told Bloomberg News. "The problem right now is there seems no way out."

Fitch Ratings downgraded Ambac to two levels to AA on Jan. 18, which in turn increased the scrutiny of Ambac, as well as other bond insurers, by other ratings firms including Moody's Investors Service and Standard and Poor's.

"The destruction of the bond insurers would likely bring write-downs at major banks and financial institutions that would put current write-downs to shame," MarketWatch reported Tamara Kravec, an analyst at Banc of America Securities, wrote in a note Friday.

Don't Panic!

Today could be one of the most brutal trading sessions the U.S. markets have ever seen. It could be bigger than 1987's Black Monday and proportionally it could even touch the levels [over several days] we saw after the 9/11 terror attacks.

But Money Morning Investment Director Keith Fitz-Gerald advises caution. 

"I want you to understand that if you run for the hills now, chances are you'll regret it for years to come," he said.

Fitz-Gerald went on to outline the following crucial points:

  1. Many global markets are actually poised for double-digit growth in 2008, even if the U.S. economy slows down. This is particularly true for those international markets that are less dependent on the United States than ever before. The process is called "decoupling" and you can see it in the data, particularly when it comes to the Pacific Rim. For instance, excluding Japan [which is still early in this process], 43% of Asia's exports go to other nations in the region up from 37% in 1995. Abandon ship now, and chances are you'll miss the boat when it sails.
  1. From chaos, comes opportunity, especially when it concerns those companies we refer to as the "global titans." Yes, these companies will drop along with the market, but with many of them paying a healthy dividend with a balanced international revenue stream, they're trading at levels not seen in years - levels that will look cheap in hindsight in the months to come.
  1. A falling dollar combined with rising energy costs and the Fed's "attention to deficits disorder" will make U.S. exporters more appealing in international markets. This appeal will add much needed stability in the face of uncertain market conditions.

Fitz-Gerald knows his advice will be tough to stomach, especially if tomorrow's markets are even half as rough as we think they could be, but history shows that investors who stay calm and add to key positions during a downturn - particularly when it comes to the "global titans" and high income plays - will be handsomely rewarded in the months ahead.

Many of these companies continue to demonstrate growing earnings and accelerating profits even under difficult market conditions. These firms will only do better when the economic environment improves.

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