• Merrill Lynch & Co’s writes down US$18.7 billion over just twelve months.
• Further financial collapses and retrenchment in consumption are a given.
• Dow Jones 11,100/11,000, its better if the support holds.

With Merrill Lynch & Co’s write downs rising to US$18.7 billion over just twelve months, with the latest quarterly addition being US$5.7 billion, the writing is on the wall, and the pavement of Wall Street, that things in the financial district may just still get worse before they get better. Share holder dilution as a means of raising fresh capital to stay afloat can only go so far for any of the major houses, after that comes further debt raisings. The spreads and very high rates of interest the investment banks would now have to pay to raise further funds, can best be described as problematic. So much for the top end of town.

At the other end of town meanwhile, the struggling consumer sits on the porch watching their fence value steadily erode. The Fed has cut rates to just 2.0%, but their bank has increased lending rates. At least fuel costs have stopped going up, but at current levels the pick up remains for sale at a fraction of the purchase cost. In middle America that long string of leveraged property purchases that were meant to elevate the family to the super-rich, now threaten the family’s very survival. The dinner table chat is dominated by whether to listen to those who say jumping on a guided bus tour to purchase homes for next to nothing as you drive through a deserted suburb is a great way to average down your property portfolio, or, to just knuckle down and stop all discretionary spending in order to just get through this, hopefully keeping current employment.

Is it any wonder all stops are out on using taxpayers money to prop up any and all major institutions that are threatened, by what is still an on-going financial and economic crisis to match and probably exceed any of our lifetime. The real problem for the US economy as a whole is that falling property values seem likely to remain entrenched in a downward spiral until December, perhaps January. Therefore further financial collapses, and retrenchment in consumption, are a given.

For equity markets we suggested a recovery of Dow Jones 12,000 and ASXSP200 5,175 would signal a sustained up-trend was getting underway. Those levels remain intact, and we have moved back now to threaten a complete collapse in any confidence that had begun to surface. The Dow Jones is still above 11,100, but only just, and the ASXSP200 is already ringing alarm bells that the funds management industry may, after last week’s false dawn, be about to completely capitulate.

Super funds are not looking quite so super after last year’s results. These organisations may, if the ASXSP200 begins to threaten fresh lows, suddenly make a run at capital preservation as this year’s key marketing tool. In other words minimises losses by having minimal market positions. This could create a self reinforcing pattern of selling followed by more selling. None of this sounds very cheery, but there is always the chance that the market has just had a return to reality on the financial stocks, while some other sectors such as resources, that relative to financials have remained stable, still represent good value. We have said here before that the recent move lower in Australia resources when combined with an Australian dollar approaching 95 cents, would prove irresistible to global fund managers. Resources and the Australian dollar should begin to rally from current levels.

We have maintained the same global-macro view consistently since September 2007, that the US would experience stagnant below consensus growth through 2008, and the rest-of-the-world would surprise with its resilience and continue to grow strongly. Nothing has changed. The outcome remains a lower US dollar, higher commodity prices, and a booming Australian export sector. Even US companies with a global revenue base have the potential to do well through this period. Certainly not as well as they would with a booming US economy, but perhaps surprisingly well given the degree and duration of the US slow down.

The worst has yet to be seen in the US. The Q2 GDP data may be firm near 2.0% or 2.1%, but a lot of this will be due to improving exports on the back of the falling US dollar. With home prices still falling, and investment banks still scampering to fully discover and disclose CDO losses, it is Q4 that is the highest risk quarter for the US economy this year. While there may be a moment of relief over a good Q2 GDP result, it may not last long.

Nevertheless, if the worst of the US slow down occurs in Q4, then it is possible for equity markets now to still be in a state of having fully priced that down-turn. In which case if the psychologically important support at 11,100, let’s say 11,000, can hold, then the broad market despite the financial sector volatility, may still have seen the major low and turnaround point. Given the events of the last couple of days that would perhaps surprise even the bulls. The next couple of days are crucial, the equity market is on a knife edge..

On the day one has to accept there is a real risk of massive capitulation of stocks globally if the Dow continues to head back toward the recent low. So adding longs on the day would be a particularly brave act, but if we can watch from the sidelines for the moment, and over the next one and two trading sessions in New York begin to see a recovery, well then we may have just survived. The alternative, of massive stock capitulation to fresh lows on top of slowing growth, is not quite so inspiring. The central message remains that this is the most challenging financial and economic period of our life time, and therefore the right global markets approach could provide the biggest opportunities of our lifetime.