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Setting Up For A Rally Or Falling Off The Fiscal Cliff?
Perspective | 07 December 2012
By: Gabriel Gan
Articles (41) Profile

In the midst of political-bickering in Washington, it seems very likely that an end to the fiscal cliff will not take place anytime soon. According to President Obama, he wants a solution to the deadlock by Christmas so that consumer and business confidence can return during the festive season.

Both sides are refusing to back down from their respective demands with no offer of a compromise. This has invited criticisms from business leaders who express disappointment with the Congress for putting partisan interest above national interest. Even legendary billionaire investor Warren Buffett openly said he does not expect the negotiations to end before the end of the year, which means that the bickering may drag into 2013 in similar fashion to when the Congress debated over whether or not to raise the debt ceiling.

By making such comments, does Warren Buffett really think that the negotiations will not come to an end by 2012 or is he trying to pressure the politicians into doing something, and doing it fast?

The Dow Jones Industrial Average (DJIA) has been on a roll since mid-November, with the index rallying from a low of 12,471 to as high as 13,089 on 5 December. Similarly, the Hong Kong stock market rallied in tandem with the DJIA, ignoring the poor performance of the Shanghai Composite Index (SSE) which fell to levels not seen since 2009.

Likewise, the Straits Times Index (STI) rallied above 3,000 points almost effortlessly although it is evident that the rally in not broad-based in nature. Trading volume was thin and activities often were limited to speculative short-term plays that typifies a market that still lacks conviction especially with the Olam-Muddy Waters saga ongoing.

Despite the huge uncertainty of the fiscal cliff, we must be contented with the fact that stock market indices rallied instead of crashing. We can only assume that investors expect the fiscal cliff to be settled, hopefully, by the end of the year and, thus, were not scared off by it.

Markets Overconfident?

With the ongoing fiscal cliff saga, weakening global economy and falling corporate profits, are investors being overconfident by driving markets higher? What are the reasons behind the bravery?

For a start, if we were to treat the fiscal cliff as a one-off event – a form of trading noise – then stock markets should really be worried because the US politicians do not have a good negotiation track record. While it is expected to be settled at the end of the day, the outcome of the terms is still a huge uncertainty. Will there be a huge reduction in budget? If there is, then will the US economy suffer as a result?

It is likely that President Obama will probably raise some basis points in the tax rate on the rich while the Republicans will not insist on such a huge cut in the budget while the Medicare and Medicaid remain, otherwise the Democrats and the Republicans will never be able to bridge the gap.

The fiscal cliff aside, we can also be sure that money from QE III has helped to prop up the financial markets just like it did during the previous rounds where market reaction was muted upon the announcement of the stimulus but moved much higher a few months later. There are reports that Hong Kong has already “benefited” from the hot money after the Hang Seng Index jumped more than 1,000 points within two weeks while the premium between the shares of Hong Kong-listed Chinese companies and those listed in Shanghai widened.

Apart from the effects of QE III and the belief that 2013 will be a better year for US and China, in particular, there is precious little that investors can be optimistic about because Europe is going nowhere except sideways or down with Germany now facing weaknesses of its own.

Sure, the QE III money will push up stock markets, create wealth effect, boost business and consumer confidence, but past experiences tell us it will not create the jobs that the US economy badly needs. On a brighter note, we can also say that jobs will be created along the way once the above conditions are met because job creation is always a lagging indicator.

Similarly in China, we are reading that the economic reports do look much better with the official 7.5 percent growth target largely achievable this year while manufacturing and export figures have started to really pick up in November.

The Xi Jinping-led government will start work only in March, which means that the current government will not be doing anything from now till March next year, which is largely what the incumbents have been doing for the past few months. They are expected to lie low for the next batch of leaders to stamp their authority by introducing policies of their own. This has been confirmed by Xi Jinping who announced that he will continue to fine-tune policies next year.

Singapore, How?

As we are an open economy, there is no way we can escape a slowdown coming from our major trading partners.

There are reports suggesting that next year will be a challenging year because of high inflation as a result of high wages. Singapore workers are said to be the highest-paid workers in the manufacturing sector, which is bad news as it will mean that we will be less competitive compared to the others especially when the Singapore Dollar has been strengthening – a move that is used to fend off inflation.

With the strong Singapore Dollar and a tightening labour force, inflation is set to remain high as we face challenges ranging from weakening demands for our exports as well as higher wages as a result of the government’s policies to restrict the number of foreigner working in Singapore.

The more serious problem, however, is how to stop property prices from climbing without bursting the bubble?

Property prices have climbed in recent years so much so that Singaporeans are complaining about houses being unaffordable. The recent influx of foreigners have also played a part in pushing up property prices, which have stayed high despite six rounds of cooling measures. This is a problem also faced by Hong Kong as Mainland Chinese rushed to buy properties in the Special Administrative Region.

If we were to look at the current property market, the “Bull Run” is charging at HDB and low-end 99-year private housing. As a result of HDB resale prices climbing, those who sold at high prices can easily pay for low-end private condominium that explains why developers are falling over themselves to bid for government land while the rest of the property market stays rather stagnant in terms of sales volume.

December Rally?

As written in the previous issue’s article, the chances of a rally remain high for the remainder of the year.

There is ample liquidity to push markets higher despite the fiscal cliff not being resolved. If not for the fiscal cliff, stock markets could have moved even higher but still faces economic challenges.

For now, expect the STI to trade between 2,980 and 3,100 while moving above 3,100 will likely see the index trying for a new multi-year high at 3,180-3,250.

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