Markets suffer painful 2008

For sure, 2008 is a year that investors will not forget for a long time.

What started out as a correction in house prices in the United States eventually dragged down virtually all asset prices. With the help of financial innovations, banks had extended too much credit over the past few years and become extremely leveraged. That leverage helped drive asset prices up in the boom years but once prices went into reverse, the high leverage also exacerbated the decline in prices.

Faced with falling asset values, overleveraged banks were forced to restrict credit, thus adversely affecting the economy as well. The US economy entered recession in December 2007 and was joined by the euro area and Japan in 2008.

Stock markets around the world fell sharply in 2008, with many experiencing record losses. The following table shows the decline in stock markets around the world based on the Morgan Stanley Capital International indices.

	Local currency (percent)	US dollars (percent)
USA	-38.58	-38.58
Japan	-43.62	-30.52
UK	-31.55	-50.56
Germany	-44.51	-47.24
France	-42.06	-44.92

And it was not just the developed markets that suffered. Emerging markets went from being big winners in 2007 to being big losers in 2008. The so-called BRIC were among the biggest casualties.

	Local currency (percent)	US dollars (percent)
Brazil	-44.50	-57.64
Russia	-72.57	-74.16
India	-56.82	-65.07
China	-52.23	-51.94

If stocks performed poorly, commodities proved to be no refuge. The Reuters/Jefferies CRB Index fell 36 percent in 2008.

Inflation fears in the early part of the year, fed by a surge in the prices of commodities in the previous few years as well as early 2008, vanished abruptly as prices experienced a major reversal midway through the year. The price of crude oil, for example, hit a record US$147.27 a barrel in July, then fell dramatically thereafter. It ended the year at US$44.60, down 54 percent for the year, its biggest yearly loss since oil futures started trading in New York in 1983.

Gold proved to be an exception to the wider trend of falling prices. Its status as a safe haven and currency alternative enabled it to post a 5.5 percent gain for the year.

The flight from risky assets meant that the yen carry trade reversed. The yen rose about 23 percent against the US dollar and 29 percent against the euro.

Risk aversion was also obvious in the bond market. For example, the spread between Moody's seasoned Baa corporate bond yield and the US 10-year Treasury yield was about 250 basis points at the start of 2008. By the end of the year, it had widened to almost 600 basis points.

Will markets see further weakness in 2009? Obviously, no one knows for sure.

Some analysts think that a recovery in 2009 is likely. They suggest that after the huge losses already seen in 2008, markets may have discounted the worst.

Furthermore, governments all over the world are taking action to mitigate the adverse impact of the financial turmoil on the economy. Monetary policies have been eased and fiscal stimuli have been planned, which should eventually lead to a recovery in the economy and financial markets.

On the other hand, others point out that the excesses in credit expansion and leverage that had been built up over the past few years were too large to be purged so quickly.

Nouriel Roubini, Professor of Economics at the Stern School of Business, New York University, Chairman of RGE Monitor and one of the few economists to have foreseen the current financial crisis, is one of those who are not optimistic.

In a recent article entitled "Will Banks and Financial Markets Recover in 2009?", Roubini wrote: "The United States will certainly experience its worst recession in decades, a deep and protracted contraction lasting about 24 months through the end of 2009. Moreover, the entire global economy will contract."

This means that for equities and other risky assets, there are still "significant downside risks". The credit crunch will get worse and deleveraging will continue.

He concludes that "2009 will be a painful year of global recession and further financial stresses, losses, and bankruptcies".