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Thursday, 12 March 2009
Risk this week’s stock low was another false bottom
The bounce in share prices over the last two days, which has seen the Hang Seng Index rebound 5 per cent from Monday’s close, is raising hopes that the equity market might finally be primed for a sustainable rally.
Risk this week’s stock low was another false bottom
Tom Holland 12 March 2009
The bounce in share prices over the last two days, which has seen the Hang Seng Index rebound 5 per cent from Monday’s close, is raising hopes that the equity market might finally be primed for a sustainable rally.
After all, with the Hang Seng Index priced at about 10 times estimated earnings for this year, or at just a shade over book value, stock valuations are close to levels at which the market has bottomed in past economic downturns.
Historically, investors who have bought when shares are this cheap have made handsome returns. And although business conditions are still deteriorating, stock prices typically begin recovering before the underlying economy.
So, as brokers are fond of pointing out, if you wait for signs that the business cycle is turning up, you will miss out on the best of the rally.
Yet investors are still nervous, and rightly so. Analysts can torture the numbers until they are blue in the face, trying to come up with convincing buy signals. But in reality, over the past 12 months, the Hong Kong stock market has been driven not by fundamental considerations of value but by contagion from markets elsewhere, primarily the United States.
If you doubt that, take a look at the first of the two charts, which shows both the Hang Seng and the US S&P 500 indices, rebased to 100 12 months ago.
The Hang Seng Index has been a shade more volatile, but the correlation could hardly be much tighter. For the past 12 months, the two markets have marched in lockstep.
That relationship won’t last forever. But in the meantime, investors wondering whether to buy back into Hong Kong equities would be wise to take a look at what’s happening in the US stock market.
At first glance, conditions look promising. With the S&P 500 at 720 points, the index is priced at 12 times estimated earnings for this year, nicely within the 10 to 12 times earnings range at which previous bear markets have bottomed out.
The trouble is that even after repeated downward revisions, earnings expectations may still be a touch optimistic.
An index level of 720 and a price-to-earnings ratio of 12 times implies earnings per share of US$60 for index stocks this year. That is at the very top of the US$50 to US$60 range that New York University economics professor Nouriel Roubini argues S&P500 companies can realistically expect for this year (compared with earnings per share of US$90 in 2007).
So, the S&P 500 could have touched its bottom this week, but if earnings per share come in at US$50 this year rather than US$60, then according to Professor Roubini, the index could “easily” fall to 600 points, or even to 500.
That’s a further decline of between 17 and 30 per cent from current levels, which, if the relationship between the US and Hong Kong markets were to hold, would imply a fall in the Hang Seng Index from 11,931 points now to 10,380, or in the worst case to 8,350.
No wonder investors are nervous.
However you look at them, China’s trade figures for February are ugly.
Exports were down a massive 25.7 per cent from the same month last year. As the second of the two charts illustrates, that’s a far more severe slump than during the Sars scare of 2003, after the terrorist attacks of 11 September 2001, or even in the depths of the Asian crisis in 1998.
In fact, the numbers are even uglier than they look. The Lunar New Year holiday fell in January this year, but in February last year. As a result, there were 20 exporting days in February this year, but only 16 last year.
If you adjust the figures to compensate for the extra working days, you get a massive 40 per cent decline in exports last month.
1 comment:
Risk this week’s stock low was another false bottom
Tom Holland
12 March 2009
The bounce in share prices over the last two days, which has seen the Hang Seng Index rebound 5 per cent from Monday’s close, is raising hopes that the equity market might finally be primed for a sustainable rally.
After all, with the Hang Seng Index priced at about 10 times estimated earnings for this year, or at just a shade over book value, stock valuations are close to levels at which the market has bottomed in past economic downturns.
Historically, investors who have bought when shares are this cheap have made handsome returns. And although business conditions are still deteriorating, stock prices typically begin recovering before the underlying economy.
So, as brokers are fond of pointing out, if you wait for signs that the business cycle is turning up, you will miss out on the best of the rally.
Yet investors are still nervous, and rightly so. Analysts can torture the numbers until they are blue in the face, trying to come up with convincing buy signals. But in reality, over the past 12 months, the Hong Kong stock market has been driven not by fundamental considerations of value but by contagion from markets elsewhere, primarily the United States.
If you doubt that, take a look at the first of the two charts, which shows both the Hang Seng and the US S&P 500 indices, rebased to 100 12 months ago.
The Hang Seng Index has been a shade more volatile, but the correlation could hardly be much tighter. For the past 12 months, the two markets have marched in lockstep.
That relationship won’t last forever. But in the meantime, investors wondering whether to buy back into Hong Kong equities would be wise to take a look at what’s happening in the US stock market.
At first glance, conditions look promising. With the S&P 500 at 720 points, the index is priced at 12 times estimated earnings for this year, nicely within the 10 to 12 times earnings range at which previous bear markets have bottomed out.
The trouble is that even after repeated downward revisions, earnings expectations may still be a touch optimistic.
An index level of 720 and a price-to-earnings ratio of 12 times implies earnings per share of US$60 for index stocks this year. That is at the very top of the US$50 to US$60 range that New York University economics professor Nouriel Roubini argues S&P500 companies can realistically expect for this year (compared with earnings per share of US$90 in 2007).
So, the S&P 500 could have touched its bottom this week, but if earnings per share come in at US$50 this year rather than US$60, then according to Professor Roubini, the index could “easily” fall to 600 points, or even to 500.
That’s a further decline of between 17 and 30 per cent from current levels, which, if the relationship between the US and Hong Kong markets were to hold, would imply a fall in the Hang Seng Index from 11,931 points now to 10,380, or in the worst case to 8,350.
No wonder investors are nervous.
However you look at them, China’s trade figures for February are ugly.
Exports were down a massive 25.7 per cent from the same month last year. As the second of the two charts illustrates, that’s a far more severe slump than during the Sars scare of 2003, after the terrorist attacks of 11 September 2001, or even in the depths of the Asian crisis in 1998.
In fact, the numbers are even uglier than they look. The Lunar New Year holiday fell in January this year, but in February last year. As a result, there were 20 exporting days in February this year, but only 16 last year.
If you adjust the figures to compensate for the extra working days, you get a massive 40 per cent decline in exports last month.
That’s not only ugly, it’s painful.
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