BT: End of bear market nowhere in sight yet (30 Jul 2008)
End of bear market nowhere in sight yet
Markets are unravelling at a rapid pace and sentiment is deteriorating with it, signalling more losses in the US and other parts of the world in Q3
By LIM SAY BOON
SEVEN months after our 'Perfect Storm' warning (BT, Jan 16), we are now in the midst of another round of financial market turmoil. Risk aversion is surging again, with accelerated losses on equity markets, rising volatility, and widening credit spreads.
But this time around, US Treasuries aren't doing all that well either - not on any optimism on the economic front but on fear of inflation despite flat US GDP growth.
Over March-May, stockmarkets staged a modest technical rebound, helped along by the 'worst is over' thesis. While we had fully expected a technical rebound - and had written about it - we were always sceptical of its sustainability. And indeed, over the months, we warned of the dangers of the 'New Complacency' and the likelihood of a retest by equities of their year's lows. That retest has been completed - with failures at critical supports sending markets all over the world plummeting past prior lows.
There is a sense of dejàvu when summing up the challenges in 3Q08. They are pretty much the same set of concerns that underpinned our bearish view of financial markets in 2Q08. And they include the likelihood of more credit market losses; another spike in credit spreads; a new round of disappointment with economic data; divergence between high earnings growth expectations and disappointing reported earnings; high oil prices; and rising inflation in the face of falling economic growth. In the case of the credit markets and the global economy, it's a case of 'unfinished business'. In others - particularly the price of oil - it's the same problem, magnified.
Capitulation is not yet evident in many markets - but be warned, it is on the way. As painful as the recent months have been to those with unhedged equities positions, the end of the bear market is nowhere in sight yet.
With the notable exception of China - where the Shanghai Composite has seen 54 per cent downside from its October 2007 peak - we have yet to see the panic and one-sided selldowns typically associated with 'capitulation'. But markets are unravelling at a rapid pace and sentiment is deteriorating with it. And with key US indices - the Dow Jones Industrial Average and the S&P500 - breaking their important 200-week moving averages, an acceleration of losses in the US and in other parts of the world is likely in 3Q08.
Toxic combination
Notwithstanding the already massive losses in emerging markets, an accelerated selldown in US equities is likely to see further 'outsized' reactions in Asia ex-Japan and emerging market equities more broadly. Just as emerging markets outperformed on the March-May rebound in US equities, they are underperforming again on renewed US weakness. Although the emerging market economies remain pillars of global growth - and they have to date enjoyed a degree of economic resilience - instant financial contagion remains the reality.
Indeed, the growth theme and ample liquidity that once drove emerging market stocks have been displaced by a toxic new combination of inflation, rising interest rates, global deleveraging, sharply diminished risk appetites and slowing global growth.
Assuming continued selling on global stock markets in coming months - rather than a drawn-out series of counter-trend rallies - value will emerge in coming months. Although forward price to earnings (PE) valuations in the US and Europe are already at lows last seen in 1990-1991, there remains a huge question mark over the reliability of those valuations given the likelihood of downward revisions to expected earnings in coming months.
Further, even with the recent large falls on emerging markets, PE ratios are still more typical of a 'mid-cycle' situation than at capitulation levels. And emerging market earnings expectations are generally even higher than those of the developed markets. With rising interest rates - and they are important in the discount rates for valuation - and a rapid economic slowdown likely in the emerging markets, we would want to see emerging market forward PE multiples beaten down even further before we accept the contrarian proposition.
With the caveat of yet lower prices and cheaper valuations, there could be buying opportunities in coming months. But for now, the risk is on the downside for stock prices. We continue to underweight equities and overweight cash on a three-month view. But over a 12-month view, we have neutral weights on both cash and equities, reflecting the likelihood of stocks bottoming and then staging a modest recovery over that time frame.
Notwithstanding the likelihood of buying opportunities emerging over the next 12 months, we would prefer to err on the side of caution at the moment and remain overweight cash just a bit longer.
The bulls reckoned the 'worst was over' in March. Beaten and bruised, they came back again last week and argued - albeit more 'sotto voce' - that the worst was over, although we have only seen some 22 per cent downside for US equities while bear market recessions see on average 35 per cent destruction in prices. The Savings and Loans crisis of the late 1980s, early 1990s saw $153 billion in losses while we have already seen asset write-offs by financial institutions totalling nearly $450 billion to date. There were more than 2000 financial institution failures during the S&L Crisis. We have only seen six such failures in the US this year. Little wonder the US Federal Deposit Insurance Corporation warns of the possibility of bigger bank failures than we have seen so far.
Equities hedge
For investors with long time horizons and an appetite for risk, dollar cost averaging is only common sense. And right now, the equities volatility index VIX is pulling back at resistance around 24 per cent. But we would not be surprised if it surges back to 35 per cent again, with another aggressive round of equities selling. So buying VIX or a delta 1 structure with VIX as the underlying could be helpful as an equities hedge. While gold remains a long-term hedge against both inflation and US dollar weakness, there is a near-term possibility of a correction after it had approached our technical forecast of $1000/oz. Indeed, the US dollar - having fallen sharply since early 2007 - could spend a bit of time trading sideways from here.
Beware getting carried away with commodities mania. While the long-term story for commodities - as a play on the emerging market giants India and China - is still valid, a correction appears to be underway with base metals already considerably off their year highs and oil easing back from its record peak. But pullbacks could be buying opportunities for diversified portfolios that do not have sufficient weighting in commodities.
Lim Say Boon is chief investment strategist for Standard Chartered Group Wealth Management & Private Bank
Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.
Markets are unravelling at a rapid pace and sentiment is deteriorating with it, signalling more losses in the US and other parts of the world in Q3
By LIM SAY BOON
SEVEN months after our 'Perfect Storm' warning (BT, Jan 16), we are now in the midst of another round of financial market turmoil. Risk aversion is surging again, with accelerated losses on equity markets, rising volatility, and widening credit spreads.
But this time around, US Treasuries aren't doing all that well either - not on any optimism on the economic front but on fear of inflation despite flat US GDP growth.
Over March-May, stockmarkets staged a modest technical rebound, helped along by the 'worst is over' thesis. While we had fully expected a technical rebound - and had written about it - we were always sceptical of its sustainability. And indeed, over the months, we warned of the dangers of the 'New Complacency' and the likelihood of a retest by equities of their year's lows. That retest has been completed - with failures at critical supports sending markets all over the world plummeting past prior lows.
There is a sense of dejàvu when summing up the challenges in 3Q08. They are pretty much the same set of concerns that underpinned our bearish view of financial markets in 2Q08. And they include the likelihood of more credit market losses; another spike in credit spreads; a new round of disappointment with economic data; divergence between high earnings growth expectations and disappointing reported earnings; high oil prices; and rising inflation in the face of falling economic growth. In the case of the credit markets and the global economy, it's a case of 'unfinished business'. In others - particularly the price of oil - it's the same problem, magnified.
Capitulation is not yet evident in many markets - but be warned, it is on the way. As painful as the recent months have been to those with unhedged equities positions, the end of the bear market is nowhere in sight yet.
With the notable exception of China - where the Shanghai Composite has seen 54 per cent downside from its October 2007 peak - we have yet to see the panic and one-sided selldowns typically associated with 'capitulation'. But markets are unravelling at a rapid pace and sentiment is deteriorating with it. And with key US indices - the Dow Jones Industrial Average and the S&P500 - breaking their important 200-week moving averages, an acceleration of losses in the US and in other parts of the world is likely in 3Q08.
Toxic combination
Notwithstanding the already massive losses in emerging markets, an accelerated selldown in US equities is likely to see further 'outsized' reactions in Asia ex-Japan and emerging market equities more broadly. Just as emerging markets outperformed on the March-May rebound in US equities, they are underperforming again on renewed US weakness. Although the emerging market economies remain pillars of global growth - and they have to date enjoyed a degree of economic resilience - instant financial contagion remains the reality.
Indeed, the growth theme and ample liquidity that once drove emerging market stocks have been displaced by a toxic new combination of inflation, rising interest rates, global deleveraging, sharply diminished risk appetites and slowing global growth.
Assuming continued selling on global stock markets in coming months - rather than a drawn-out series of counter-trend rallies - value will emerge in coming months. Although forward price to earnings (PE) valuations in the US and Europe are already at lows last seen in 1990-1991, there remains a huge question mark over the reliability of those valuations given the likelihood of downward revisions to expected earnings in coming months.
Further, even with the recent large falls on emerging markets, PE ratios are still more typical of a 'mid-cycle' situation than at capitulation levels. And emerging market earnings expectations are generally even higher than those of the developed markets. With rising interest rates - and they are important in the discount rates for valuation - and a rapid economic slowdown likely in the emerging markets, we would want to see emerging market forward PE multiples beaten down even further before we accept the contrarian proposition.
With the caveat of yet lower prices and cheaper valuations, there could be buying opportunities in coming months. But for now, the risk is on the downside for stock prices. We continue to underweight equities and overweight cash on a three-month view. But over a 12-month view, we have neutral weights on both cash and equities, reflecting the likelihood of stocks bottoming and then staging a modest recovery over that time frame.
Notwithstanding the likelihood of buying opportunities emerging over the next 12 months, we would prefer to err on the side of caution at the moment and remain overweight cash just a bit longer.
The bulls reckoned the 'worst was over' in March. Beaten and bruised, they came back again last week and argued - albeit more 'sotto voce' - that the worst was over, although we have only seen some 22 per cent downside for US equities while bear market recessions see on average 35 per cent destruction in prices. The Savings and Loans crisis of the late 1980s, early 1990s saw $153 billion in losses while we have already seen asset write-offs by financial institutions totalling nearly $450 billion to date. There were more than 2000 financial institution failures during the S&L Crisis. We have only seen six such failures in the US this year. Little wonder the US Federal Deposit Insurance Corporation warns of the possibility of bigger bank failures than we have seen so far.
Equities hedge
For investors with long time horizons and an appetite for risk, dollar cost averaging is only common sense. And right now, the equities volatility index VIX is pulling back at resistance around 24 per cent. But we would not be surprised if it surges back to 35 per cent again, with another aggressive round of equities selling. So buying VIX or a delta 1 structure with VIX as the underlying could be helpful as an equities hedge. While gold remains a long-term hedge against both inflation and US dollar weakness, there is a near-term possibility of a correction after it had approached our technical forecast of $1000/oz. Indeed, the US dollar - having fallen sharply since early 2007 - could spend a bit of time trading sideways from here.
Beware getting carried away with commodities mania. While the long-term story for commodities - as a play on the emerging market giants India and China - is still valid, a correction appears to be underway with base metals already considerably off their year highs and oil easing back from its record peak. But pullbacks could be buying opportunities for diversified portfolios that do not have sufficient weighting in commodities.
Lim Say Boon is chief investment strategist for Standard Chartered Group Wealth Management & Private Bank
Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.
posted by mrmoon at 8:52 AM
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