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Clear And Present Danger Threatens To Derail Bull Run
Perspective | 14 June 2013
By: Gabriel Gan
Articles (41) Profile

It is the time that some investors have been waiting for – a correction, one that is long overdue. But funnily, some investors are too afraid to buy even though they have vowed to take the plunge once there is a 5 percent to 10 percent correction.

It is fear and greed at work yet again, as greedy investors want stocks to go cheaper so that they can buy at even lower prices while fearful investors dare not jump into the stock market for fear that the market may end up much lower.

From a high of 15,942 on 23 May, the Nikkei 225 dropped to as low as 12,548 within two weeks, rebounded to 13,584 before tumbling yet again to as low as 12,415 on 13 June. From the trading high to the lowest point, the index lost a total of 22 percent but from the close of 15,627 on 22 May to the close of 12,445 on 13 June, the Nikkei lost 20.3 percent and is now in bear market territory unless it manages to reclaim some losses in the near term.

In Hong Kong, its performance mirrors that of the Shanghai Stock Exchange Composite Index (SSE) as well as most major markets in the world. The Hang Seng Index (HSI) went as high as 23,512 on 20 May but traded as low as 20,652 on 13 June, losing 12.1 percent in all. During the correction process, the HSI broke the 21,400 and 21,098 supports to end below 21,000 points – levels not seen since October and November last year.

The SSE probably fared the best despite signs that liquidity has become tight and strong economic growth is a thing of the past with the government’s new policy. After Ben Bernanke made remarks about a possible exit from the stimulus measures, the index actually rose even higher but gave way to profit taking. On 29 May, the index closed at 2,334 but fell rapidly to an intra-day low of 2,126 on 13 June, shedding only 8.9% compared to other global bourses.

Even the normally resilient Straits Times Index (STI) could not beat the performance of the SSE. Our local index traded as high as 3,464 on 22 May and fell without much reprieve, falling to as low as 3,094 on 13 June. The fall in the index was caused by losses in stocks that gained very quickly i.e. banks and telecom stocks, not forgetting the Jardine stable.

The Fear
This current correction, while long overdue, is not unexpected as I have warned a fortnight ago in the article entitled “More danger signals appear: Is it just a blip or are we about to experience a major correction?”

When Nikkei first started to drop, there were signs that the huge stimulus package announced by the Japanese government would not be enough to stem the rot in the Japanese economy. But recently, the Japanese economy did a lot better than expected but it did not help the stock market apart from a mild rally. In the first quarter, Japan’s growth domestic product (GDP) rose 4.1 percent – much better than the 3.5 percent originally announced. However, there is a much bigger picture that had investors worried.

The expectations of a watered-down quantitative easing (QE) III, already much-talked about by US Fed officials, have already battered global markets with a particular focus on Asian markets. The Dow Jones Industrial Average (DJIA) hit an intra-day high of 15,542 on 22 May and retreated to a low of 14,844 on 6 June – a mere 700-point gap – to outperform most global markets despite the US being the originator of the correction.

Why does the end of the stimulus programme present such a big problem?

The entire rally in the global stock market was fueled by an unprecedented amount of liquidity and, most importantly, cheap credit facilities available. The low returns on risk-free and low-risk assets have forced investors to seek higher returns and/or yields, hence, the stock market or instruments have become more attractive to investors.

Now that liquidity may soon be drained away from the financial system, it is only natural that investors have turned panicky after being used to so many years of ample and cheap liquidity fueling a stock market Bull Run that has yet to effectively translate into benefits for the real economy and the people on the streets.

From a psychological point of view, a reduction in the bond buyback programme is tantamount to denying drugs to an addict who is used to receiving strong doses. The process will be painful, there will be withdrawal symptoms but all will be well once the addict kicks the habit. We are probably now at the stage whereby investors need to get used to the idea of a world without stimulus measures but whether or not such a move drags the world into a recession or if the world economy can stand on its own without government aid remains to be seen.

Asian Worries
Ever wondered why commodity or even oil-related stocks failed to participate in the rally during the last few months? Ask China.

When China was at its economic peak, it bought almost everything under the sun to fuel its industrialisation process and commodities were the darlings of the market. After China raised interest rate and reserve ratio to fend off inflation, its economy stopped growing at a blistering pace and the Chinese government had a hard time fighting inflation and, more importantly, high property prices that is still being viewed not as an economic problem but also a social one that may lead to unrest.

Add together Europe’s problems and China’s dilemma, the commodities sector especially gold has been hit real hard.

There are now concerns about China’s continued tightening of liquidity which may lead to a credit crunch. However, China is now more focused on areas that require investments as opposed to previous policies whereby money is available to everybody and anybody. China’s weaker growth going forward has raised questions about the entire Asian economy’s strength especially when India, too, is facing such problems. If Asia is no longer favoured by investors, then funds – including hot money – may be flowing elsewhere if they are not drained off in the future.

Rising Bond Yields A Concern
It seems that investors are beginning to brace themselves for an eventual rise in government bond yields after Japan’s government bonds spiked up despite pledges by the Bank of Japan to keep interest rate low while trying to stoke inflation. Investors are not convinced that interest rates can remain low while inflation climbs, Hence, that is one of the reasons why the Nikkei is in a free-fall.

Similarly, we are seeing yields on the 10-year US treasuries rise despite the Fed’s bond buyback programme of US$85 billion a month. Yields on the 10-year treasuries spiked up to 2.269 percent on 11 June but fell slightly to 2.17 percent on 13 June after Bernanke reassured investors that a reduction in the stimulus package does not mean an end to QE III.

If bond yields continue to rise, it will mean that investors are more and more convinced that interest rates will eventually rise and stocks may come under even more pressure while companies that are highly geared will be the first to get hit once interest expenses go up.

The stock market is very often the crystal ball of the economy some six months down the road, meaning investors are sure that the global economy may not do as well as previously thought especially now that QE III may soon be reduced and eventually stopped.

Watch next week’s FOMC meeting on 18-19 June like a hawk. After coming out to reassure investors that a reduction in stimulus measures does not spell the end of QE III, the Fed Chairman may likely alter his language to soothe nervy investors

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