KEY POINTS:
When the sub-prime crisis rocked world markets on July 27, New Zealand's sharemarket followed the same dismal path as Wall Street. It sank almost 10 per cent in less than a month.
But the NZX-50 index stopped just short of a fresh closing high on Tuesday and overseas markets have also recovered. The sorry episode appears to be fast disappearing in the rear view mirror.
However sharemarkets do not represent any country's entire economy, and some commentators argue the fallout from sub-prime and the credit crunch that followed represents a huge change in financial fundamentals that is likely to run for some time yet.
Sharemarkets received a huge shot in the arm from the half a percentage point cut to US interest rates by the Federal Reserve Bank last month.
The move was hailed as an example of the "Greenspan Put", an implicit guarantee the Fed would act if things got too dicey in the sharemarket. In any case, it restored confidence to Wall Street and global markets, at least in the short term.
And while the credit squeeze saw a string of bank failures, including that of Northern Rock in Britain, more confidence has been restored since some major institutions disclosed the extent of their losses resulting from exposure to sub-prime.
Man Investments' head of institutional business in Australia and New Zealand Urs Alder, in New Zealand this week briefing advisers on the implications of the recent turmoil, says that while the losses are bad news, markets dislike uncertainty and it's a case of better the devil you know. Alder, who worked for Man's "fund of hedge funds" Glenwood in the US before taking the job in Australia, sees plenty of fallout to come. "My opinion is clearly we haven't seen the bottom of this."
He says there are limits to the power of the Greenspan Put. "Trust has to come back into the system. If that doesn't happen the Fed can do whatever it wants and in the short term, sure, the equity markets move up. But the Fed cannot force the borrower to buy or consume and they cannot force the bank to lend."
He believes the probability of a US recession has risen significantly, putting it at 45 to 50 per cent.
Alder is convinced the US housing downturn has further to play out, and falling house prices means increased mortgage defaults, especially as the low "teaser" rates enjoyed by borrowers for the initial period of the loan roll off.
That means the sub-prime situation could get worse, but it will also likely impact on US consumer demand.
"Harley-Davidson has restated their expected sale of motorbikes down quite a bit. What that tells us is that even the high-end consumer market is affected."
Goldman Sachs JBWere economist Shamubeel Eaqub's views are similar to Alder's. "The US economy has slowed considerably and will continue to do so. Anybody who thinks that a 50 basis point cut is going to revive the economy is very much mistaken."
Eaqub puts the probability of a US recession at 40/60. "The big issue is that this is the first time since World War II that they have faced such widespread declines in house prices."
Eaqub says the most dramatic effects may have passed but there are still several months of fallout to flow through the global economy. "What happens with these things is that there is a shock. And once that shock dissipates people reassess."
Markets might be growing again but the drivers of growth are not the same as before. "It's the composition of the appreciation that's important. Which companies are driving this upturn? I suspect that it is not the same as it was 12 months ago."
The equities recovery aside, there is still a lack of liquidity in financial markets which is likely to ensure borrowing costs remain high for some time, even in spite of the Fed's cut and the prospect of more to come.
"The passing through of higher borrowing costs will go on for the next six to nine months," says Eaqub.
"There is a pipeline effect that is still going to flow through. It's too early to say that we've seen the downturn hit the trough."
Alder believes corporate and other economic fundamentals will continue to deteriorate over coming months. He points to the likely downward rating of a large chunk of US corporate bonds and rising defaults over the next two or three years.
Many of those same US corporates will also be having to refinance short term bonds and bank debt, and given the current conditions in credit markets, that will be an expensive exercise, adding to the pressure.
"I definitely expect default rates in the corporate side to move up."
Meanwhile, there are probably more ugly surprises lurking on US banks' balance sheets in the form of bridging finance they extended to private equity outfits during the latter stages of the leveraged buyout boom.
Ordinarily, the banks would package up those loans and sell them off. The credit crunch has made that very difficult. In fact, Alder says, some of the bigger private equity outfits, who were the recipients of the loans in the first place, are buying them back off the banks at 92c to 95c in the dollar.
There are an estimated US$370 billion worth of such loans on US banks' balance sheets.
"If you assume you lose 5 to 8 per cent on those loans well that's probably close to US$20 billion in total losses that we'll see, this is not even taking the sub-prime market fully into the picture."
Alder thinks economic growth in the US will be affected and while to some extent China and India's economies will take up some of the global slack, "the US is fairly important".
"As much as the US is not the driver of global growth anymore, they still influence the markets massively with the Fed's decisions."
Westpac chief economist Brendan O'Donovan has an altogether more upbeat view. While he believes there is a risk that the credit market turmoil could "seriously derail" the global economy: "We are optimistic that the world economy is suffering a speed-wobble rather than engine failure".
Westpac puts the probability of serious global meltdown involving a "full blown US recession" at 25 per cent. Such a scenario, could reverse much of the recent commodity price gains which O'Donovan believes have paved the way for "a golden era" for the New Zealand economy.
That aside, New Zealand is relatively well placed to weather further global ructions thanks to the strong local currency. "If the global economy implodes, our exchange rate will likely drop like a stone, buffering the impact on our exporters and dispersing the pain by making consumers take some of the hit in the form of more expensive imports."
Furthermore, our high interest rates could be slashed if required.
Westpac's more likely scenario sees the "information deficit" on the extent of the sub-prime damage ease, relatively low US mortgage defaults, credit markets loosening up , and asset markets continuing to make progress.
Westpac, while seeing prospects of a US recession as still reasonably high, runs the "decoupling" line. China, India and economies in the rest of the world will be relatively immune to the US problems.
Even more upbeat - about the sharemarket anyway - is ASB Securities head of retail broking Stephen Wright, who says there are a few specific reasons why the NZX has bounced back so well in the past month.
One is the extent to which our market is propped up by M&A activity such as that seen in SkyCity and Auckland Airport.
"If anything transpires in either of those two the money has to go elsewhere in the market."
Another is that the Telecom capital repayment has released more money back into the market. Some people have even reinvested that with Telecom which has had a steady run since mid-August. It has risen 11.5 per cent since then to close at $4.56 yesterday.
Accounting for 20 per cent of the total market, a rising Telecom often means a rising market.
"With Telecom now you just get the feeling that Paul Reynolds is not going to be antagonistic to the Government and the regulatory authorities so they're going to get on with doing what they should have done," Wright says. "They've still got problems, but having said that, it seems as if peace is going to break out."
When the New Zealand market plummeted in August a lot of the selling came from foreign hedge funds desperate to get hold of cash.
"When Wall Street was really bad and everyone was really anti-risk, our dollar was also really bad. But now that risk worries are lower, the dollar has picked up and that does encourage the offshore investors, who may think the dollar is still going higher."
Given his upbeat view of New Zealand's prospects, Westpac's O'Donovan believes a US85c New Zealand dollar is possible if the recovery in global risk sentiment continues.
If that is an ugly prospect for exporters, they can take some comfort from Alder.
"I don't think this little spike in market volatility that we've had is the full story, it would be too nice if it was."
