ALMOST a year into the US sub-prime crisis and equity markets around the world are still reeling from its fallout. In US dollar terms, Hong Kong’s Hang Seng Index is down 24 per cent year to date, the Straits Times Index 22 per cent, while the stock markets of China and India have dropped 52 and 36 per cent, respectively.
More... text / pdf
1 comment:
Wall St still irrationally exuberant
2 September 2008
ALMOST a year into the US sub-prime crisis and equity markets around the world are still reeling from its fallout. In US dollar terms, Hong Kong’s Hang Seng Index is down 24 per cent year to date, the Straits Times Index 22 per cent, while the stock markets of China and India have dropped 52 and 36 per cent, respectively.
Given such gloomy numbers, contrarians might be tempted to surmise that it would be a good time to buy soon, especially if we assume that 10-12 months is sufficiently long for reasonably efficient markets to discount future problems.
It might be that, in time, such a strategy will prove profitable. The biggest obstacle to this scenario, however, was - and remains - an over-optimistic Wall Street. Despite facing the worst US housing and financial crises in decades, a weak currency, poor earnings, rising inflation and the prospect of higher interest rates, the major US indices have lost just 13 per cent in 2008.
According to the latest estimates, the S&P 500 trades for a current earnings multiple of 26 and a forecast figure of 15, which means that US companies will have to report huge earnings growth of more than 50 per cent next year in order to justify current prices. Given that the full effects of the slowdown have yet to be felt and that the latest earnings reporting season was disappointing, such outsized growth is unlikely.
So where does Wall Street’s relative outperformance come from? A major reason is implicit and explicit guarantees from US officialdom that, if necessary, companies which are deemed too large to fail will be bailed out.
This was the message first conveyed in March when the US Federal Reserve took extraordinary steps to save failed investment bank Bear Stearns. This policy continues today, with strong hints from the US Treasury that government-sponsored mortgage providers Fannie Mae and Freddie Mac - which are tottering at the edge of bankruptcy - will be nationalised if necessary.
Bailing out the stock market and the economy is, of course, not new. Most recently, it occurred after the dotcom crash of 2000 when short-term interest rates were aggressively slashed to almost zero quickly to stave off recession. Because this then caused the housing bubble, whose subsequent bursting has led to all the present woes, it might be argued that embarking on bailouts every time there is the possibility of a major collapse is thus an unwise strategy.
Apart from encouraging mini-bubbles, it also instills complacency and a false sense of security. More relevantly, it requires printing a large amount of dollars that will, in time, undermine the currency and push inflation and interest rates higher.
Contrarians keen to buy when everyone else is selling should therefore take note: US investors are still irrationally exuberant and stocks could therefore be primed for much more volatility ahead.
Post a Comment