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Monday, 18 May 2009
Play this as a V-shaped recovery for now
There’s nothing like a wild stock market rally to fire the imagination, stir the senses and get analysts talking about green shoots, V-shaped recoveries, virtuous cycles and the birth of a new bull market.
There’s nothing like a wild stock market rally to fire the imagination, stir the senses and get analysts talking about green shoots, V-shaped recoveries, virtuous cycles and the birth of a new bull market.
From their March 9 lows to their highs earlier this month, the Straits Times and Hang Seng indices each gained an identical 54 per cent - an incredible bounce that has caught many by surprise and led some to declare the bear market is over. These optimistic souls suggest the economy, business and growth will quickly be back to normal, perhaps as early as the third quarter.
Yet despite the supposed quick turnaround that the market’s behaviour is forecasting, scepticism abounds. A senior colleague said recently: ‘Every thinking commentator I’ve come across believes this green shoots business is vastly overdone.’
And another said in a column in last Thursday’s BT - ‘A slowing decline is not a recovery’ - that the present economic situation is like ‘a punctured balloon simply being supplied with enough gas to prevent it falling to earth while still doomed to remain suspended just above ground level’.
It’s not just journalists who doubt this talk of green shoots - surely a term that will go down in history as one of the market’s most memorable catch-phrases, up there with ‘irrational exuberance’ and ‘this time, it’s different’.
Bank of America-Merrill Lynch, after looking at New York Stock Exchange short-selling data, said in a May 1 US Economic Commentary that the March-April rally that added 30 per cent to Wall Street’s indices at the time was due mainly to massive short-covering. It also said that most of its big-money clients do not believe the turnaround will be quick because, among other things, history suggests it takes economies about four years to work off the impact of a burst credit and asset bubble.
Meanwhile, in an article last Wednesday, the Associated Press quoted analysts saying that the encouraging first-quarter earnings reported by US banks were thanks to ‘accounting tricks’ and ‘fuzzy math’ that made these institutions look healthier than they really are (http://money.aol.com/article/all-business-accounting-tricks-boost/473370).
There has been no improvement in the banks’ core businesses, said the article, pointing out that some simply reduced their provisions for loan losses, while others simply wrote down the value of their own debt to reflect its current market value - and booked the difference as income.
Here’s how the latter trick works: Say a bank issued debt at 100 cents on the dollar and that debt now trades at 60 cents on the dollar. The bank marks down the value of the debt on its books to 60 cents on the dollar - and takes a gain on the 40-cent difference, because in theory it can buy back that debt for less than it paid and pocket the difference. Neat, isn’t it? But analysts quoted in the AP report pointed out - correctly - that this kind of illusory income is not sustainable or recurring and should be excluded. It wasn’t.
There’s more (for example, one local economist last week looked at the poor US retail sales data and pondered whether the green shoots will soon suffer from fungus attacks), but by now you probably get the picture - there are valid reasons to question the ‘wisdom’ rooted in green shoots and ‘V’ shapes, and it pays to be sceptical of talk of a fast recovery.
The more relevant question however, as far as investors are concerned, is: How should one play the present market?
For the past six weeks, the advice we have given has been the same - there is sufficient momentum and liquidity to justify playing this as a V-shaped recovery because that is what the markets want to believe, but bear in mind that there is an even chance of an ‘L’, ‘U’ or ‘W’ materialising.
We would estimate that the probability the eventual shape does turn out to be a ‘V’ to be about 25 per cent at best because the US economy has only just started its painful deleveraging process, and the good old days when large investment banks dominated a bloated lending landscape - and by extension the economy - are well and truly over.
In comparison, the chance of a ‘W’ or double-dip might reasonably be set slightly higher at 30 per cent if the green shoots fail to take root, while the remaining probability of 45 per cent is split evenly between ‘L’ or a lengthy ‘U’.
In all cases though, investors should stay nimble and sceptical - because the preoccupation with a few green shoots may already have led markets to overshoot.
1 comment:
Play this as a V-shaped recovery for now
By R SIVANITHY
18 May 2009
There’s nothing like a wild stock market rally to fire the imagination, stir the senses and get analysts talking about green shoots, V-shaped recoveries, virtuous cycles and the birth of a new bull market.
From their March 9 lows to their highs earlier this month, the Straits Times and Hang Seng indices each gained an identical 54 per cent - an incredible bounce that has caught many by surprise and led some to declare the bear market is over. These optimistic souls suggest the economy, business and growth will quickly be back to normal, perhaps as early as the third quarter.
Yet despite the supposed quick turnaround that the market’s behaviour is forecasting, scepticism abounds. A senior colleague said recently: ‘Every thinking commentator I’ve come across believes this green shoots business is vastly overdone.’
And another said in a column in last Thursday’s BT - ‘A slowing decline is not a recovery’ - that the present economic situation is like ‘a punctured balloon simply being supplied with enough gas to prevent it falling to earth while still doomed to remain suspended just above ground level’.
It’s not just journalists who doubt this talk of green shoots - surely a term that will go down in history as one of the market’s most memorable catch-phrases, up there with ‘irrational exuberance’ and ‘this time, it’s different’.
Bank of America-Merrill Lynch, after looking at New York Stock Exchange short-selling data, said in a May 1 US Economic Commentary that the March-April rally that added 30 per cent to Wall Street’s indices at the time was due mainly to massive short-covering. It also said that most of its big-money clients do not believe the turnaround will be quick because, among other things, history suggests it takes economies about four years to work off the impact of a burst credit and asset bubble.
Meanwhile, in an article last Wednesday, the Associated Press quoted analysts saying that the encouraging first-quarter earnings reported by US banks were thanks to ‘accounting tricks’ and ‘fuzzy math’ that made these institutions look healthier than they really are (http://money.aol.com/article/all-business-accounting-tricks-boost/473370).
There has been no improvement in the banks’ core businesses, said the article, pointing out that some simply reduced their provisions for loan losses, while others simply wrote down the value of their own debt to reflect its current market value - and booked the difference as income.
Here’s how the latter trick works: Say a bank issued debt at 100 cents on the dollar and that debt now trades at 60 cents on the dollar. The bank marks down the value of the debt on its books to 60 cents on the dollar - and takes a gain on the 40-cent difference, because in theory it can buy back that debt for less than it paid and pocket the difference. Neat, isn’t it? But analysts quoted in the AP report pointed out - correctly - that this kind of illusory income is not sustainable or recurring and should be excluded. It wasn’t.
There’s more (for example, one local economist last week looked at the poor US retail sales data and pondered whether the green shoots will soon suffer from fungus attacks), but by now you probably get the picture - there are valid reasons to question the ‘wisdom’ rooted in green shoots and ‘V’ shapes, and it pays to be sceptical of talk of a fast recovery.
The more relevant question however, as far as investors are concerned, is: How should one play the present market?
For the past six weeks, the advice we have given has been the same - there is sufficient momentum and liquidity to justify playing this as a V-shaped recovery because that is what the markets want to believe, but bear in mind that there is an even chance of an ‘L’, ‘U’ or ‘W’ materialising.
We would estimate that the probability the eventual shape does turn out to be a ‘V’ to be about 25 per cent at best because the US economy has only just started its painful deleveraging process, and the good old days when large investment banks dominated a bloated lending landscape - and by extension the economy - are well and truly over.
In comparison, the chance of a ‘W’ or double-dip might reasonably be set slightly higher at 30 per cent if the green shoots fail to take root, while the remaining probability of 45 per cent is split evenly between ‘L’ or a lengthy ‘U’.
In all cases though, investors should stay nimble and sceptical - because the preoccupation with a few green shoots may already have led markets to overshoot.
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