Friday night’s downgrade of US debt was such a momentous step that few economists can explain what it actually means, but there are some worrying predictions floating around, including a fall in demand for resources and the dumping of recently-launched takeover bids.
Macarthur Coal is a case study of what can happen when economic and political confidence is shocked, which is exactly what happened when ratings agency Standard & Poor’s cut US long-term debt from AAA to AA+, the first such cut in US history.
On the table is an offer from Peabody Energy to buy Macarthur shares for $15.66, with a possible top-up to $16. Macarthur management wants $18.
Until Friday, Macarthur was trading as high as $15.94, close to the upper level of the Peabody bid. By the time the market closed on Friday Macarthur was trading at $15.21 and had been as low as $15.05 – almost $1 a share less than Peabody’s proposal and close to $3 a share less than what management thinks its shares are worth.
There is a powerful message in what is happening at Macarthur. It is investors saying that asset values are too high and everyone needs to take a haircut, just like the US has been forced to take a haircut.
Sundance Resources is another example. It has an offer on the table from Hanlong Mining at 50c a share. Until Friday it had traded up to 54c as speculators took positions in the hope of a bidding war forcing Hanlong to pay more. By Friday night Sundance was trading at 46c.
Some of the sellers of Macarthur and Sundance shares were panicked punters, or forced sellers who had been trading on credit – but not all.
Older investors have seen what happens when a sea change of sentiment rolls through a market, when optimism turns to pessimism, and the bears replace the bulls.
The S&P downgrade of the US was major bear signal. Critics claim it was S&P trying to reclaim some authority after missing the sub-prime mortgage scandal and misreading the true value of collateralised debt obligations, which triggered the 2008 global financial crisis.
Perhaps there is some truth in the ratings agencies being extra cautious this time around but even if that is the case it means that the world must take notice. If a second ratings agency follows S&P then some investment funds will be forced to sell US Treasury bonds because their rules only permit the holding of AAA securities.
At best, a period of significant asset re-allocation has started, with nervous investors shuffling their deck of bonds, shares and foreign funds.
At worst, there will be a rush into the safest securities available, which should be led by gold but which, ironically, might actually be US AA+ Treasury Bonds as the least worst option, because no one believes New Zealand is as credit-worthy as the US even though they now share a rating, or that Britain, France and the Isle of Man deserve to retain their AAA ratings.
Dryblower’ point is that S&P has issued a wake-up call, one that says too much of the world is dependent on credit and that the world is running out of banks and countries that can provide the credit to keep the merry-go-round, well, going round.
Now for the really nasty bit.
After the 2008 crisis it was China which kept the music playing because it had a deep repository of savings and was able to launch a spending blitz that drove commodity prices to new peaks.
Will China do it again? Will it ride to the rescue of the debt-laden western world again?
Or can it even afford to, because there are signs of a debt crisis building in China too.
UBS, an investment bank, reckons China’s commercial banks have been making massively risky loans to property developers as part of the keep-China-growing-at-all-costs edict issued by the central government.
If China cracks then the world really will enter a new era of austerity, not to the same extent as what’s happening in Greece, but a time of rising taxes, falling government spending, reduced investment, and lower commodity prices.
It will be a time when quality wins through and weak assets are discounted.
It will also be a time when the Australian government wakes to discover that its favourite cash cow, the mining sector, might not be such a juicy tax target after all, and that forking out money on green-energy dreams might not be such a good idea.
All bets, as they say, are off.
