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Wednesday, 1 October 2008

Stay cool as markets unravel

Goh Eng Yeow advises trigger-happy traders to keep their cool.

REJECTION of a US$700 billion bailout package for financial institutions by US lawmakers has sent stock markets reeling across the world on Tuesday morning.

Regional bourses such as Singapore, Tokyo, Hong Kong and Sydney have each fallen by up to 5 or 6 per cent, with heavy falls in financial institutions dragging down their bank-dominated indexes, in a knee-jerk reaction to Wall Street's worst-ever one-day point plunge of 778 points.

Traders in Asia can only watch helplessly in horror at the high drama unfolding in the United States, as two banking giants - Washington Mutual and Wachovia - were rescued in the past two weeks, while government officials and central bankers wrangled with politicians to cut a deal to inject a dose of confidence into a battered financial system to prevent even more banks from failing.

The US contagion has also spread to Europe where Dutch-Belgian bank Fortis and property lender Hypo Real Estate had to be rescued over the past two days.

Systemic risk is the biggest fear unsettling global investors now, as they flee into the safest types of assets possible - US government bonds, gold and precious metals.

What is systemic risk ? It is a special type of risk associated with financial institutions, with the failure of one bank triggering other banks to collapse because of its inability to repay them.

The vast number of mortgage failures in the United States since last August has raised concerns that there may be big undisclosed mine-fields beneath the balance sheets of many banks. This has made banks so suspicious of each other because of possible systemic risks that they have effectively stopped lending to each other - causing a huge credit crunch as the financial markets effectively freeze up altogether.

For over a year, Asian markets have been largely immune to the credit crunch afflicting Europe and the United States. But since last week, there has been a sudden spike in short-term interest rates, and this is putting big pressure on counters whose bottomlines will feel the squeeze of higher interest rates. In Singapore, the big losers have been property counters which have traditionally relied on cheap credit to finance their luxurious condo projects while offering buyers attractive deferred payment terms.

But while Singapore banks have fallen in line with the decline in the rest of the markets, they have been spared the selling pressure which has hammered US and European lenders. They are among the best capitalised banks in the world, having bolstered their capital base further by raising billions only a few months ago through preference share issues. And they are further insulated from the global financial turmoil because their lending exposure is mostly to the domestic market.

Fortunately, for traders here, there is the Hari Raya Puasa holiday on Wednesday to get some breathing space, as the US government tries to hammer out another deal to rescue its battered financial institutions. Hong Kong will also enjoy a reprieve tomorrow as it joins China National Day celebrations.

But they have to bear two points in mind:

* The temporary ban on short-selling of financial stocks in the United States will be lifted on Thursday unless it is extended. Even with the ban, US financials such as Morgan Stanley and Goldman Sach - the two remaining Wall Street titans still standing - have been whacked as investors stampede out of them. It will be difficult to gauge what investors are going to do, once the short-selling curbs have been lifted;

* US lawmakers will make another attempt later this week to come to an agreement before going home to face re-elections in November. Will they bite the bullet after rejecting the bailout deal last night ? As it is, the plan has already come under heavy fire for buying troubled assets at unspecified prices, with many US taxpayers believing that their elected representatives are throwing good money after bad.

Some have suggested that the political game players can be persuaded to change their minds, after being chastened by Wall Street's plunge which wiped out about US$1.2 trillion worth in stock value.

But others note that it is going to be difficult to predict how US Congress is going to react going forward, given the rejection of what was supposed to be a done deal hammered out on Sunday. They also observe that alternative suggestions to get the US government to rescue wobbly financial institutions directly, rather than buy their troubled assets, are gaining ground. So it is likely that there will continue to be a gridlock with no balm-relieving action in sight.

In view of all these uncertainties, trigger-happy traders may be wise to keep their powder keg dry, as the high drama unfolds in the United States.

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