Third quarter earnings season is still ongoing but if you read closely into the numbers, fundamentals have barely improved, which stand at odds to the heady valuations arising from this stock market rally. On the bright side, JP Morgan and Goldman Sachs reported blowout earnings. However, trading is the name of their game which has little bearings on lending, production and gainful employment in the real economy.
It is unclear how well the balance sheets of the remaining Wall Street bastions stand up to scrutiny when interest rates are raised, mark to market accounting resumed and all the fanciful Fed’s creations (like Primary Dealer Credit Facility, Commercial Paper Funding Facility, Term Asset-Backed Securities Loan Facility, Term Securities Lending Facility Options Program, etc) are withdrawn.
Ben Bernanke is reluctant to raise low interest rates but he has been quick to toast his “success” in saving America and the world from financial meltdown. Bernanke said: “History is full of examples in which the policy responses to financial crises have been slow and inadequate, often resulting ultimately in greater economic damage and increased fiscal costs. In this episode, by contrast, policymakers responded with speed and force to arrest a rapidly deteriorating and dangerous situation.”
While Ben Bernanke’s resolve in throwing money from his helicopter is impressive, history will remember him fondly not for the amount of dollars he can print in record time nor his financial creativity but rather the exquisite timing of his exit strategies. Liquidity injections canot continue indefinitely without leading to massive asset bubbles. The Fed will have to pull the trigger (I hope sooner rather than later) and that will lead to a shakeout for equities, commodities and dollar short-sellers.
Harsh facts are never appreciated when everybody is having fun at the party. Lest I keep repeating the same old bleak story and being deemed as a gate-crasher or scare-monger, I have refrained from posting too often in this blog. But it will be remiss of me not to mention that this rampant bullishness prevading the stock market is raising alarm bells.
Today, we are, at best, peering into a nascent economic recovery but Dow Jones Industrial Average have already crossed 10,000 (about 30% off the all time high of 14,198 in October 2007) when peak euphoria reigns amongst investors. If that is not getting ahead of ourselves, I don’t know what is.
Bank of America gave us a measure of reality by reporting a $1 billion loss, its fifth straight quarterly loss. To be sure, the financial sector is still in murky waters. What has changed over the last year is not the debt crisis but rather a reshuffling of cards. Instead of transferring risks to unknowing investors through securitized debts, the US government has been forced to gobble these toxic assets and shoulder immense financial risk.
The solvency of major financial institutions has come at the expense of insolvency to the US government. If financial institutions get into trouble again, what are the odds of the US government mustering another rescue when its credit is hanging in the air? Can the Federal Reserve double money supply as coolly it did over the last year? Will taxpayers, consumers and investors not bat an eyelid as their purchasing power and dollar denominated assets go into the dumps?
Knowing that the next financial crisis could require as much, if not, more resources to resolve, and the Federal Reserve could be found sorely lacking by then as the dollar loses its status as the world’s reserve currency, it is rather baffling that financial institutions are still resisting reforms to get their house in order. Perhaps it is inevitable that this unregulated financial system, as we know it today, has to crash into oblivion and be rebuilt from the ground up again.
I have nothing against attractive remuneration for top performers. You can’t fault traders who netted, say, $1 billion and they lay claim to 50% of profits while the owners and creditors who came up with the capital get the rest. However, when the traders lose $3 billion the following year and even compromised the company’s financial position, they lose nothing except their bonuses or jobs while shareholders, bondholders and even taxpayers have to step in to pick up the tab. Capitalism is not about privatising rewards while socialising the risks, but apparently the rules of the games can be changed.
Dollar Crisis And Commodities Boom?
Reckless money printing by the Federal Reserve has devalued the dollar, and we can expect a dollar crisis to play out within the next decade. Already, murmurs of discontent are getting louder amongst key players.
Rumors are rife that a meeting among Arab States, China, Russia, and France hopes for a discontinuation of oil trading in U.S. dollars. In the short term though, the dollar could strengthen as the stock market experience a major setback but its demise is inevitable if federal debts continue to pile up and the US economy weakens.
Currently, the US government is not in a hurry to defend the dollar. Without turning off the printing presses and reining in excess liquidity, Timothy Geither has only paid lip service to the notion that that America supports a strong US dollar. Exporting nations in Asia are left with little choice but to implement currency intervention, in light of narrowing US trade deficit which signals a rebound in US exports.
The dollar crisis has lent weight to investors like Jim Rogers who believe that commodities is the best place to be. I don’t doubt his words as supply and demand support his judgment. In fact, crude oil could very well run out in a generation’s time. If oil continues its uptrend, other commodities (food, metals, etc) are bound to follow.
But until the global economy gets back on a firm footing, any commoditiy boom is far-fetched. China, in its bid to sustain 8% economic growth for “social stability,” may well have decoupled from the deflationary environment in the US. China’s voracious domestic consumption is looking very promising, just over their eight day National Day holidays, retail sales of consumer goods surged 570 billion yuan, up 18% compared to last year.
But it is impossible for the Chinese to pick up all the slack in global consumption. Thus, while a collapse in commodities is unlikely, prices may fall from current levels and stay low for a while. That will actually benefit a weak US economy which is 70% dependent on consumption.
Printing more money which results in inflation and then runaway prices of oil and food is self-defeating. Raising interest rates will cause a sell-off in commodities which is a boon for consumers and businesses rather than a stock market rally fuelled by speculation and greed.
For those who are thinking of using commodities as an inflation hedge, it is also not a wise idea. Fortunes can be made or lost on a wrong bet, even for seasoned investors who study technicals and fundamentals closely.
A Global Double Dip Recession
Another rapid slump in global economy is far from impossible. Double dip recession could arise from sky-high public debts or another financial crisis sparked by delinquency in prime mortgage loans, risky commercial sector or derivatives. Geopolitical rivalries in the Middle East and Noth Korea also threaten stability. And not to forget trade conflicts which could result in protectionism or rather beggar thy neighbor policies.
If the global economy slids back again, a fresh round of stimulus packages could be harder to coordinate in the face of precarious budget deficits and debts. This could be the start of a multi-year recession, lasting at least 3 – 5 years.
America is moving in a similar trajectory as Japan when they lost their way after a housing bubble burst in the ’90s and bad loans overwhelmed their financial system. Till today, Japan has not really emerged from its lost decade. It is too early to say if Ben Bernanke has steered America away from the crippling deflation which plagued Japan or banished the ghost of the Great Depression.
Despite the stock market rally, consumer spending has not picked up. Equities may have enriched a select few but Americans are still struggling with job losses and lower income. In August, it was reported that consumer debt declined a further $12 billion, marking the seventh month of debt contraction in a row.
Since the credit crisis struck, consumers have reduced their debt by a record $113 billion (excluding mortgages). Either Americans are tired of using credit for discretionary spending or the credit crunch has not really abated as banks remain fearful of making loans.
Not surprisingly, US retail sales fell in September after the Cash for Clunkers program ended. Hopes are now on the fourth quarter where the retail industry brings in the bulk of its profit but I am keeping my fingers crossed as record unemployment will dampen holiday sales.
Dark Clouds Behind Singapore’s Economy Recovery
Singapore was the first Asian nation to announce a recession but its economy has rebounded with an 14.9% expansion (following the 22% growth in the second quarter), prompting the government to raise its full-year economic outlook. Being an export oriented nation, our modest recovery bodes well for the health of most Asian economies.
Nevertheless, MAS has kept its monetary policy steady, being cautious about the sustainability of this recovery. If private consumption in the developed nations do not increase when effects of stimulus programs wear off, we have to brace ourselves for a W-shaped recovery.
There is no doubt that things are picking up but it is too early to pop the champagne. In fact, I believe next year will be similarly, if not, more challenging. The sole pillar of our economy during this harsh recession was the construction industry which attained double digits growth while other sectors languished.
However, this sector is losing some steam. As it is, construction dipped by 0.6% while manufacturing and services were up 35% and 9.5% respectively. There could be more contraction to come. Due to lacklustre interest from buyers in 2008, many developers were vexed by their inventories and were on the verge of selling at greatly discounted prices. Interest in bidding for new plots of land was scant. Fortunately, demand for mass market residential properties spiked in recent months.
Construction companies will feel the brunt of this “quiet” period next year, just when most of their existing projects are completed. Competition for new projects, especially from the private sector, will be keener, driving down prices. We can expect fewer companies reporting fat profits and there could even be a weeding out of the weak players which will increase unemployment figures.
The integrated resorts (two biggest construction projects in Singapore) are scheduled for completion by mid 2010. Whether new public projects can absorb all the resources being freed up remains to be seen. The “idle” situation may persist for a while as private developers are still building their land banks and the planning and approval process takes time. Hopefully, by then, other sectors of the economy will have firmed up sufficiently.
In view of the challenging times ahead, I believe the stock market is too optimistic with its valuations of 15-25 times earnings. Stocks have rallied aggressively since March. Most of them are trading above their 200-day moving average and with no sign of slowing down. In this kind of bullish environment, fundamental analysis seems really foolish. A monkey, with no baggge of knowing how bad things really are, could have made huge profits just by throwing darts in the dark.
It is at moments like these when rational investors are blinded by greed and let their guard down. If you are seduced by lucrative gains made from stock market speculation, count yourself in good company.
Sir Issac Newton, a man renowned for his achievements in the field of physics, was left in financial ruin when he succumbed to the South Sea bubble. In 1720, the South Sea Company’s shares soared before plummeting and becoming worthless. It has no viable business but it was able to issue shares due to insatiable demand from investors, aided by rumors and speculation.
We should not forget that in the short term, the stock market behaves like a voting machine, swayed by emotions and fuelled by momentum, but in the long term, it is a weighing machine. Fundamentals have to come into play but of course, the million dollar question is when. Unfortunately, nobody can time the market accurately.
The bullish momentum may not exhaust itself just yet as there are no shortage of investors coming round to the idea that “this time, it is different,” so more cash is expected to flow into the stock market. It is getting close to a final hurrah though.
Rather than being obsessed with calling a market top, we should just maintain a neutral stance and stay vested, or for the risk averse, take profits off the table (which I have done progressively since August). By divesting all our stock holdings, we may miss out on more upside. I am not keen to buy more stocks but if you want to do so, remember to keep your stop losses tight and never maximise your leverage.