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Monday, 22 June 2009
Market Mood
According to modern portfolio theory, if a portfolio has different assets such as commodities, bonds, currencies and stocks, risk can be minimised because different assets have different growth trajectories and are not highly correlated.
According to modern portfolio theory, if a portfolio has different assets such as commodities, bonds, currencies and stocks, risk can be minimised because different assets have different growth trajectories and are not highly correlated.
But that theory did not hold as the world was rocked by the financial crisis last year and the correlation among different asset classes surged. As a result, diversification could not minimise risk and many investors were left wondering if diversification was such a good strategy after all.
Financial crises of the proportion we have just witnessed, however, are special cases and one cannot possibly base one’s investment decisions on them.
According to Yale University, whose endowment is growing at 16 per cent per annum, economic cycles can be divided into four phases. The correlation of different assets would be highest in the “recession phase”. Once we get past that stage and move into the “calm phase”, the correlation will diminish. That explains why emerging-market equities have performed very well this year, many of them approaching the so-called golden cross (where the 50-day moving average is above the 250-day moving average). The next two phases are “speculation” and “turbulence”, which are similar to a bubble phase.
Owing to the massive stimulus package by the central government, the Chinese economy has recovered the fastest among the major countries. China’s firmness in dealing with recession has cemented its status as a rising star, strengthening its appeal for foreign capital. This has been partly responsible for the rise in stock prices of late.
The worldwide implementation of the quantitative easing policy has triggered fears of inflation, especially as commodity prices rise at the slightest signs of recovery, causing hot money to retreat from the red-hot China market.
During the financial crisis, commodity prices dropped dramatically, immensely helping manufacturers. But China’s manufacturing industry was adversely affected as international demand flagged as a result of the crisis. To make up for lost sales abroad, the sector is targeting the domestic market with renewed vigour, which could well drive prices down. So deflation is really what China ought to be worried about, not inflation.
While the consumer price index fell 1.4 per cent year on year in May, the producer price index (PPI) fell 7.2 per cent.
Remember, both CPI and PPI figures are comparisons with last year’s data. In the first half of last year, oil was over US$100 and other commodity prices were going equally strong. So CPI and PPI were at relatively high levels this time last year. Comparing their figures with this May, it’s hardly surprising that the indices have dropped significantly. But it would be wrong to construe this as looming clouds of deflation over China’s horizon.
I personally see neither a threat of inflation nor of deflation in China. In such a relatively stable price environment, I think a loose monetary policy rate will be maintained and there will be no interest rate rises in the coming year. The government will keep boosting domestic spending and investment with a view to stabilising the economy and maintaining its growth rate. Any increase in interest rates is bound to hinder growth.
The United States is not facing any threat of inflation either. The May CPI in the US also dropped 1.3 per cent year on year, its greatest fall in nearly 60 years. That should put at rest any lingering fears over a period of inflation.
The massive monetary and fiscal stimulus packages have stabilised the world’s biggest economy and restored market confidence. Banks in the US are again in a position to repay the government loan that was needed to bail them out.
The US Treasury department has announced that 10 large banks will repay US$68 billion of the Troubled Asset Relief Programme (Tarp). With the loan paid back earlier by some of the small banks, the total comes to US$70 billion.
Clearly the mood is decidedly bullish. The easing of the US banks’ problems is a positive sign as it will increase the risk appetite of investors, leading to liquidity flows into high-growth markets such as China.
The central government can be expected to continue its proactive fiscal policy and moderately ease the monetary policy. Neither is it expected to raise interest rates in the foreseeable future. These factors, when combined, can be expected to stimulate the mainland stock and property markets and increase consumption, in turn boosting the overall economy and the stock market.
If such a positive loop does indeed take hold, it is difficult to see the market going in any direction other than up.
2 comments:
Market Mood
Paul Pong
21 June 2009
According to modern portfolio theory, if a portfolio has different assets such as commodities, bonds, currencies and stocks, risk can be minimised because different assets have different growth trajectories and are not highly correlated.
But that theory did not hold as the world was rocked by the financial crisis last year and the correlation among different asset classes surged. As a result, diversification could not minimise risk and many investors were left wondering if diversification was such a good strategy after all.
Financial crises of the proportion we have just witnessed, however, are special cases and one cannot possibly base one’s investment decisions on them.
According to Yale University, whose endowment is growing at 16 per cent per annum, economic cycles can be divided into four phases. The correlation of different assets would be highest in the “recession phase”. Once we get past that stage and move into the “calm phase”, the correlation will diminish. That explains why emerging-market equities have performed very well this year, many of them approaching the so-called golden cross (where the 50-day moving average is above the 250-day moving average). The next two phases are “speculation” and “turbulence”, which are similar to a bubble phase.
Owing to the massive stimulus package by the central government, the Chinese economy has recovered the fastest among the major countries. China’s firmness in dealing with recession has cemented its status as a rising star, strengthening its appeal for foreign capital. This has been partly responsible for the rise in stock prices of late.
The worldwide implementation of the quantitative easing policy has triggered fears of inflation, especially as commodity prices rise at the slightest signs of recovery, causing hot money to retreat from the red-hot China market.
During the financial crisis, commodity prices dropped dramatically, immensely helping manufacturers. But China’s manufacturing industry was adversely affected as international demand flagged as a result of the crisis. To make up for lost sales abroad, the sector is targeting the domestic market with renewed vigour, which could well drive prices down. So deflation is really what China ought to be worried about, not inflation.
While the consumer price index fell 1.4 per cent year on year in May, the producer price index (PPI) fell 7.2 per cent.
Remember, both CPI and PPI figures are comparisons with last year’s data. In the first half of last year, oil was over US$100 and other commodity prices were going equally strong. So CPI and PPI were at relatively high levels this time last year. Comparing their figures with this May, it’s hardly surprising that the indices have dropped significantly. But it would be wrong to construe this as looming clouds of deflation over China’s horizon.
I personally see neither a threat of inflation nor of deflation in China. In such a relatively stable price environment, I think a loose monetary policy rate will be maintained and there will be no interest rate rises in the coming year. The government will keep boosting domestic spending and investment with a view to stabilising the economy and maintaining its growth rate. Any increase in interest rates is bound to hinder growth.
The United States is not facing any threat of inflation either. The May CPI in the US also dropped 1.3 per cent year on year, its greatest fall in nearly 60 years. That should put at rest any lingering fears over a period of inflation.
The massive monetary and fiscal stimulus packages have stabilised the world’s biggest economy and restored market confidence. Banks in the US are again in a position to repay the government loan that was needed to bail them out.
The US Treasury department has announced that 10 large banks will repay US$68 billion of the Troubled Asset Relief Programme (Tarp). With the loan paid back earlier by some of the small banks, the total comes to US$70 billion.
Clearly the mood is decidedly bullish. The easing of the US banks’ problems is a positive sign as it will increase the risk appetite of investors, leading to liquidity flows into high-growth markets such as China.
The central government can be expected to continue its proactive fiscal policy and moderately ease the monetary policy. Neither is it expected to raise interest rates in the foreseeable future. These factors, when combined, can be expected to stimulate the mainland stock and property markets and increase consumption, in turn boosting the overall economy and the stock market.
If such a positive loop does indeed take hold, it is difficult to see the market going in any direction other than up.
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