Tuesday 16 December 2008
Investors Should be Wary of Underestimating Risks - Again
In a nutshell, investors should be wary of placing too much faith in their hope to keep markets afloat, at least until the present disconnect between the underlying economy and market expectations converge. In short, be careful of underestimating risk again.
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Investors Should be Wary of Underestimating Risks - Again
By R SIVANITHY
15 December 2008
Hope, it’s said, springs eternal. In the US, Wall Street hopes that its carmakers will be bailed out by the Bush administration tapping into its US$700 billion fund that was supposed to help unfreeze credit markets. In addition, it also hopes that the US Federal Reserve will continue cutting interest rates after tomorrow’s Open Markets Committee meeting, never mind that all previous rate cuts have not had an effect.
In this part of the world, punters hope for a year-end rally that often involves window-dressing of the major indices which in 2008’s case, will be aimed at hiding poor performance.
Brokers and analysts, in the meantime, hope that after underestimating the risks in 2008, they’ll get it right in 2009 so the majority of recommendations that have been issued over the past week were - surprise, surprise - of the ‘buy’ variety.
The main danger in all of this is the same as it has been throughout this year, which is that everyone seems to be once again underestimating risk.
One reason for this is the use of most recent history as a gauge of the market’s health and drawing comparisons to argue that stocks are cheap. Thus, several recent strategy reports have argued that because the present price/book is roughly the same as during the 2002-3 Sars downturn or during the 1998 regional crisis, then a trough has been reached.
What these analyses have failed to take into account is a tottering and essentially bankrupt US economy which may still plunge into a deep abyss even if its bankrupt government manages to successfully bail out its bankrupt car industry. In other words, there seems to be a disconnect between the economic outlook and the stock market’s discounting process - the former is bad and looks set to get worse while the latter is pinning its hopes on continued government support and rescues.
To illustrate, here is what DBS’s Economics & Market Strategy report last week said of the local economy: ‘Growth outlook for Singapore is pointing south. Uncertainties in the global financial market and consumer pessimism continue to loom overhead. Downside risks to global growth remain high. Many of our key export markets are heading towards a substantially slower growth path or are already in recession.
‘A small, open economy like Singapore is especially susceptible to such weakness in global demand. In addition, while the external environment will continue to remain hostile for the next 12 months, domestic demand will also weaken amidst the softer labour market, delays to several mega construction projects. . .growth outlook for Singapore will worsen. . .’
JP Morgan’s Friday comment on the outlook for the local market was probably the most succinct we’ve seen. ‘Disaster avoidance is probably the best short-term investment philosophy: We expect the next three to six months to be dominated by tactical stock selection driven by how much (or how little) balance sheet quality and earnings resilience has been priced into stocks.’
It also said the FY08 results reporting season in Jan/Feb 2009 will be critical in providing the appropriate signals of corporate operational and financial health as well as assessing how much additional equity capital may be required by those companies with too much leverage.
Finally, Macquarie Research in its Dec 8 Asia Strategy said earnings estimates for Asia ex-Japan as a whole are still too high. ‘Our guess is that the current 2009 earnings growth forecast may turn out to be approximately correct, but it will be from a much lower 2008 base than is currently being forecast (. . .the final 2008 earnings growth outcome could easily be somewhere between -30 and -40 per cent),’ Macquarie said.
In a nutshell, investors should be wary of placing too much faith in their hope to keep markets afloat, at least until the present disconnect between the underlying economy and market expectations converge. In short, be careful of underestimating risk again.
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