Watch the contagion
Focusing more on economic risk. We believe the ongoing US credit troubles pose a
risk to real activity in the wider US economy although the global equity markets seem no
longer to be pricing in a financial systemic crisis. US Fed’s swift liquidity injection may
have assured the global market participants that it has the tools to ensure that a full-blown
liquidity crisis is avoided. However, it remains uncertain that it has the ability to prevent a
slowdown in the US economy from tightening credit conditions. Weakness is most likely to
seep out of the credit market and spread to the US consumer and ultimately to the rest of
the global economy, in our view. According to our economists, what started as a UScentric
housing shock has started to move more noticeably toward a broader consumption
slowdown, and now arguably risks morphing into more of a “global-financial-conditions
shock” if the Fed response is inadequate. If so, our Asia Economics Research team thinks
we would no longer be dealing with just a slowdown in US residential investment, but with
a potentially greater threat to Asian growth.
Signs of softness in some global macro indicators before mid-August sell-off.
Adding to our concerns, the above transmission mechanism is playing out against the
backdrop of some signs of softness in parts of the global data including our GS global
leading indicator (GLI). Global macro news in late July and early August had been
signaling the increasing risk of a pause in equity markets. While our Global Economic
Research team maintained its view that the global industrial cycle was set to accelerate in
2H2007, the latest industrial news had hinted that the best news may be behind us for now.
As our global economist, Jim O’Neill discussed recently, we do still see strong growth
dynamics in the BRICs (China in particular) as providing an important offset to US
concerns. In our recent meetings with the US investors, many agreed with Jim O’Neill’s
view in our Global Markets Daily on Aug 15 that China’s retail sales are contributing about
as much to global growth as US retail sales (0.6% vs. 0.7%) and that retail sales for the four
BRIC economies are currently contributing nearly 1.5% to global growth, which is more
than twice the contribution from the US (see Global Markets Daily: Thank God for China!,
Aug 15). This provides the basis for the “Asia decoupling” argument that the US centric
credit problem and its threat to US consumers are a challenge for Asia that could be
managed with a limited impact on the underlying economic expansion.
But while few would argue against the current robustness of the global economy outside
the US (China in particular), US subprime and broader credit re-pricing related issues and
their contagion effect to US consumers and the rest of global economy should remain at
the center of many investors concerns for some time. If growth concerns increase as credit
conditions tighten, or financial systemic concerns increase, the equity markets including
the KOSPI will likely again come under pressure along with significant volatility spikes.
KOSPI has reclaimed two-third of the lost ground during the risk reduction in mid-August.
But the level of investor confidence implied by the KOSPI’s move seems weak.
Assessing the collateral damage.
There are two main pass-through channels to the KOSPI from the credit market
dislocations and US housing and consumer stress: de-risking to lower valuations and the
damage to earnings growth.
