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Saturday, 15 August 2009

Making sense of the recent market rally

One important reason for the bullishness is that the market has already discounted much of the bad news

RECENTLY, one of my clients told me he was confused about the significance of the recent market rally. Many of the blue chips such as Singapore Airlines, NOL, SGX and CapitaLand are still making quarterly losses. On top of that, some 47 companies listed on the Singapore Exchange have announced quarterly results with combined earnings lower than the previous quarter.

On the job front, unemployment is still rising. According to the manpower ministry, the worst is not over yet. This is the first time employment has contracted for two consecutive quarters since the 2003 economic downturn.

GDP for 2009 is expected to contract by 4 per cent to 6 per cent. ‘Aren’t all these bad news for the stock market?’ he asked. Over the last four months, equities have done extremely well with the Dow Jones Industrial Average up 20 per cent; the Standard and Poor’s 500, 23 per cent; and the Straits Times Index (STI), 56 per cent.

Our property market has also picked up with queues forming outside some new show flats. HDB resale flat prices have surged to a record high which prompted the minister of national development to caution that speculation is creeping back into the market.

What is going on? Why is the stock market going up when the economy is still struggling? Who are buying these homes in a recession? Is it the start of an economic recovery and is the worst behind us?

Singapore’s latest export data support indications that we are recovering from its deepest recession to date. Non-oil domestic exports (NODX) fell 11 per cent in June from a year ago, compared with a 12.3 per cent decline in May.

At times like this, even a slight rebound makes things look better than they are, not forgetting that the Singapore economy is expected to grow only 3.5 per cent in 2010. So why is the stock market looking bullish despite weak economic data?

The answer comes from legendary fund manager Mark Mobius and billionaire investor Warren Buffett. Both of them believe that the stock market is a leading indicator of the state of the economy. In other words, it predicts what the economy will look like in six to nine months.

I’m no economist, but I’ll share a few of my observations. The unemployment rate may be high, but it is a lagging indicator of economic activity. From past recessions, unemployment keeps rising even after an economic turnaround begins.

Singapore’s gross domestic product (GDP) fell hard in the first quarter of 2009 and was followed by large numbers of layoffs. Neither of these statistics is good news. These numbers suggest that deflation could be on the horizon. Deflation or falling prices during a recession is a troubling sign and could lengthen the recession but this does not seem to be happening.

On the property front, Singaporeans’ keen interest in property doesn’t fade even in a recession. Currently, there is plenty of liquidity and mortgage rates are relatively low. So, many are looking to buy property to take advantage of the low interest rate environment. There were reports that the private property market is well supported by HDB upgraders who only need to pay a little more to upgrade as HDB resale prices are also rising.

One important reason for the bullishness is that the market has already discounted much of the bad news. Major indexes fell more than 40 per cent last year. But this doesn’t mean the market will ignore all bad news. Unexpected news can still take the market lower. Currently, the market is responding to what the economic landscape is expected to look like in six months. As such, I believe there’s a good chance that the market is beginning a bottom-building process.

Keeping in mind that the stock market looks ahead by six to nine months, the revelations of the past year have long been digested by the market. This was also true during the Asian financial crisis when the STI fell to a low of 800 points in mid-1998. It was all doom and gloom and a few months later Singapore was in a technical recession, coupled with massive job losses and poor corporate earnings.

Stockmarket behaviour can be a sign of things to come, particularly the economy. The question here is whether we believe that the fundamentals have improved enough to merit a 9,000 in the Dow Jones, or a 900 in the S&P 500 or even a 2,600 on the STI. In other words, are stocks fully valued at this time?

For a sustained rally, there has to be real earnings growth or positive earning surprises, improving home sales, higher employment, proof that inflation will not be a major problem down the road. Until positive data becomes consistent, we can expect the markets to start and stop, go up and down with an upward bias. If the data worsens, then stocks will once again retrace their downward spiral, maybe even hitting previous lows.

In my 20 years of practice, most successful investors I know tend to focus not so much on today. What is expected to happen tomorrow is more important. In the short term, the market is unpredictable and subject to great volatility. But in the very long term, the stock market has had a strong upward bias. I don’t know of any reason to think that that would change. This is a key point that’s easily overlooked in investors’ frantic search for the direction and the ‘right’ answers that they hope will yield instant gratification.

Personally, I believe that brighter days are ahead and that, someday, most of us will look back on the past two years as a very painful period that we managed to get through. Getting to that future won’t be easy, but it will be a lot easier for people who can keep their heads when others seem to be losing theirs.

Ben Fok
CEO, Grandtag Financial Consultancy (S)

Source : Business Times – 15 Aug 2009

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