Is This A Big One?

Gripped by fear of another recession, the financial markets suffered their worst day Thursday since the crisis of 2008. The Dow Jones industrial average fell more than 500 points, its ninth-steepest decline ever. The sell-off wiped out the Dow's gains for 2011. It put the Dow and broader stock indexes into what investors call a correction _ down 10 percent from the highs of this spring.

The guiding factor permeating the scene was that governments seems to have "NO PROPER SOLUTIONS" to the current and looming sovereign debt crises.

Having said that, FEAR took over as frightened investors were so desperate to get into some government bonds that they were willing accept almost no return on their money. Since July 21, the Dow has lost more than 1,300 points, or 10.5 percent of its value. It has closed lower nine of the 10 trading days since then. This wasn't a sudden thing, the fact that we have 9 days of down markets indicated something was not right, the big drop was somehow a climax after the 9 days of "not-Christmas-at-all".

For the day, the Dow closed down 512.76 points, at 11,383.68. It was the steepest point decline since Dec. 1, 2008. Thursday's decline was the ninth-worst ever by points for the Dow. In percentage terms, the decline of 4.3 percent does not rank among the worst. On Black Monday in 1987, for example, the market fell 22 percent.

First it was the US debt ceiling. Almost immediately after that was solved, concerns about the economy took over, and the selling only accelerated. On Thursday, growing fear about the weakening U.S. economy was joined by concern in Europe that the troubled economies of Italy and Spain might need help from the European Union.

The European Union has already given financial assistance to Greece and Ireland, two countries that have struggled to pay their debts. A financial rescue package for Italy or Spain might be more than the group of countries can handle.

In an indication of how frightened investors are, Bank of New York Mellon said it would start charging large investors to hold their cash. The bank's clients include pension funds and large investment houses. Other market indicators reinforced the risk-averse mood. Gold, which is seen as a safe investment when the stock market is turbulent, set a record price, $1,684.90 an ounce, before falling to finish the day at $1,659. Adjusted for inflation, gold is still far below its record high, reached in 1980.

The yield on the 10-year Treasury note fell to 2.42 percent, its lowest of the year, and the yield on the 2-year Treasury note hit its lowest ever, 0.265 percent. Bond yields fall when demand for bonds increases. The yield on the one-month Treasury bill fell to almost nothing _ 0.008 percent. Investors were willing to accept paltry returns in exchange for holding investments they believed to be stable.

Then came last night, when it finally dawned on traders in Europe and North America that there is almost no way to avoid an economic calamity. European stocks set the scene for fresh global falls when they tumbled to a level not seen since after the financial crisis in mid-2009. Italy's equity market sank firmly in bear market territory - down nearly 30 per cent since February - as investors worried the eurozone debt crisis was spreading.

Italy's blue-chip FTSE MIB Index was suspended about 30 minutes before the close. The index tumbled slightly more than 5 per cent. The CBOE volatility index, or VIX, known as Wall Street's fear gauge, jumped 35.4 per cent to 31.7, its highest in more than a year. The move was the biggest jump since February 2007, which came during the US subprime mortgage meltdown.

Italy, Spain

Markets were unconvinced the ECB bond buying will be effective in stopping contagion and some were disappointed that Italian and Spanish bonds, whose yields climbed above 6 per cent recently, were not the target of the purchases.

It wasn't a unanimous decision to (buy bonds). (ECB President Jean-Claude) Trichet looked really uncomfortable saying it. The market, obviously, dismissed it pretty rapidly," another trader said. Markets were unconvinced the ECB bond buying will be effective in stopping contagion and some were disappointed that Italian and Spanish bonds, whose yields climbed above 6 per cent recently, were not the target of the purchases.

"It wasn't a unanimous decision to (buy bonds). (ECB President Jean-Claude) Trichet looked really uncomfortable saying it," one trader said.

WHAT TO DO

a) Fear index has gone very high to 34, even if you are thinking of bottom fishing, you can do it when VIX starts to drop.

b) One thing to remember is that liquidity is still very strong in the global arena, its just that we are having a sovereign debt issue.

c) If a very big company goes bust, we can get the government to step in to rescue. What happens when governments go bust, who can we ask to step it? Collectively, the EU cannot manage to save Greece, Italy and Spain all at once. They will be trying very hard to find a solution. To me, the best solution is for the affected countries to STEP OUT OF THE EUROPEAN UNION and work their way out of their problems. Get back when they have met certain thresholds. That way, each country can use their own currency and interest rate to adjust their economy without affecting the rest of EU.

d) All that still makes emerging markets as the only shining bright lights. Will their demand for exports be curtailed? Well, they already have for the past 2 years. Emerging markets have been trading more among themselves. I expect funds to shift to emerging markets in a big way.

e) I do not see a similar sell down pattern for Asia. I see a rebalancing positively towards the second half of the day.

f) I think we can expect CHINA to play a very big surprising stabilising role today. If China comes in and offer help with some of Italy and Spain bonds, it would not be just EU fixing things.

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Oil and Stock Prices Correlation

The guys at Bespoke Investment Group research have done it again, a quite important piece of discovery - the correlation between stock prices and oil prices. Oil prices, much like the price of gold has not really dented the stock markets upswing for the past 12 months. Each time gold prices or oil prices inches higher, the stock markets greeted it with a weak applause. Theoretically both oil prices and gold prices should have a significant "negative" impact on stock prices. Why have these two not affected share prices?



Oil prices because of the lowering of margins for many industries, and for impacting negatively on the cost of final goods and services. Gold as a reflection of inflationary fears or market disequilibrium or global unrest fears.

Bespoke: From the start of the bull market back in March 2009 until just recently, oil and the stock market had a seemingly wonderful relationship. Most of the time, when stocks moved higher, oil moved higher as well. On the rare occasion that equities headed lower, oil tagged along to the downside. This wonderful relationship has recently become strained, however, and the two have seemingly chosen to go their separate ways.

Below is a chart highlighting the rolling 1-month correlation between the S&P 500 and oil (using daily % changes) since the start of the equity bull market on March 9th, 2009. The higher the number on the positive side, the more closely the two are moving together. The lower the number on the negative, the more the two are moving in the opposite direction. As shown, the correlation between the stock market and oil remained positive up until just recently, but the breakup between the two has been swift and extreme. At the moment, the one-month correlation between the two stands at -0.70.

The correlation chart is a good way of showing how high the stock market was allowing oil to go before oil's price began to affect stocks. Oil rallied alongside stocks from the $30s to the $80s, but once it got into the high $80s and then broke $90 and finally $100, the stock market began to break away and move lower. With oil now into the triple digits, stocks are simply heading in the opposite direction of the commodity on a daily basis.

The question everyone has now is whether the stock market can adjust to oil at these levels, or whether oil will need to pull back before stocks can start to head higher again.

The thesis that share prices can only stomach the price of oil up to a certain extent sounds good but difficult to stomach logically. Bespoke said that only when oil prices move past $80 that they start to affect share prices. To me, its an argument but not entirely persuasive. One may say that up to $80, industries can safely pass on the higher cost of oil without impacting on final demand. Things turn awry beyond $80 as end consumers would not be able to accommodate further jumps in product prices.



While the above para sounds plausible, I have another theory for the correlation chart anomaly. Share prices have been rising despite oil moving higher from $60-$80 because the world and most companies have already come to terms in living and managing in a world with high oil prices. Ask most companies, they would have spreadsheets pricing oil at $90, $100, even $130 or $140. We drivers have learned to live with ever increasing fuel and gas prices, 2 or 3 times a year anyway.

Another plausible way to explain the correlation anomaly is the something out of the ordinary has occured whereby stock prices would then go into tailspin regardless of how oil price moved. Are the Libyan and Egypt crises such type of events? I think by itself, these two events are not sufficient to rock the boat. The alarming thing was how pervasive and viral it became, suddenly almost all of the Middle East and parts of North Africa may be in for a sustained revolt, that may explain the divergence in correlation. We now have a better understanding that the other nations may not implode the way Egypt did or Libya is experiencing, maybe I should not use the word "implode", maybe I should use "regenerate" or "rejuvenate".

I believe the $80 turning point is only one of the major turning point to end users to explain the divergent behaviour of share prices beyond that level. The other would be the speculation. Call it whatever, black swan anticipation theory, hedging, etc... once oil prices surges past $80, we saw a lot of scrambling by corporations, traders, hedge funds, the run of the mill fund managers, private bankers etc... to take speculative positions of do hedging for their portfolios, revenue streams, protection on their costing model and raw materials.

The surge in activity probably sent oil prices to an overzealous territory. Oil prices is a very liquid instrument for all. All it took was for the top few hedge funds who were happy going long in stocks, to start to cash out of stocks and then "play oil futures" as their new temporary playground, causing a rush for the party, causing some over heightened anxiety by genuine businesses - which is why i still think the price of oil is overplayed now. How else can you explain fully the divergence from the chart above. Purely on the fact that oil price beyond $80 is really bad does not cut it for me.

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Market Commentary

You can say a lot of things about the market or you can say that there is nothing much to say. Global macro developments have been causing a stop-start to other markets that were having a ball of a time. That is unavoidable, and presents a convenient excuse for the more active markets to take profits every now and then. I do not see liquidity leaving the bullish markets, in fact more are pouring in with the woes in Europe looking to be a lot more drawn out.


I still think the markets are OK, for Malaysia, I see 1650 as a reasonable target by March 2011. Beyond that, I will have to assess the macro developments and the execution swiftness of the ETP and other big projects.

Even CPO prices have chipped in boosting the related counters, though I am not entirely a big fan yet of CPO counters. You can have high prices but not high sustainable demand.


On a side note, JCY is moving closer to where I see good value, around 76 sen (please read my last posting on JCY). Semicon and related industries are highly cyclical, some may have harped too much on their latest quarter's results, but its cyclical, roll with it. They are never going to be smooth. The harping may have some merit if you track back to how CIMB brought the company public - here is where the research departments will frown and throw papers when asked by investment banking side to write a 'good report'. Even when it was just listed, most knew that the reports circulating then were pretty optimistic. Me included, I gave them too much credit, luckily I changed sides when it broke RM1.50.

It was "not right" for any decent research unit to NOT acknowledge that cyclical forces have turned and its was "not right" to just lower expectations, its a blood bath. The same can be said for Notion Vtec, these are not bad companies, in fact they are quite well run. But they are in an industry that is always a lot bigger than the companies, and they ebb and flow, as much as you can try to plan you will always be swallowed. Take your time to buy at the bottom cycle - just another two or three more months should be dandy.

The question many people ask is why the property swaps deals do not trade closer to their purported price. In a strong market, they will. Unfortunately they were caught in the North Korean silliness. But that is not the main reason. The news is out, most of these stocks were "over-owned" leading up to the deals, if the news followed a strong market, then everyone would be happy to hold, and vice versa. Secondly, the pricing, when you are swapping you tend to swap at higher book values than was normally the average for the past year. So IJM Land swap at 3.65 and MRCB at 2.30 ... why at that price, they could have done it at 5.00 and 3.50 ... does that mean the share price will go there? Of course not. As the actual ex-date draws closer, they will, provided people like the deal.


I think the 3 big property deals so far have been reasonably priced, with IJM Land coming out with a good pricing advantage. Besides timing, the next catalyst should be the announcement of the mega RRI Sg Buloh land project, so be prepared to hold a while. However, it is likely to announce the RRI project prior to the completion of the deal and not after, because that would formally secure real intent of having both companies to complete the deal.

Same for Sunway group of companies, but their completion date is faster. Bearing in mind that there is capital repayment via cash dividends, the combined share will face immediate selling pressure in the first few days and may dip lower than 2.80, but longer term the prospects are very good.

The market is led by property and more property stocks. I read Avenue Securities' latest take on SP Setia: "It is fully valued at this juncture. SP Setia has delivered strong property sales of RM2.1bn up to Sep 2010 which underpins earnings visibility for the next 2-3 years. However, we believe this has already been priced-in, likewise the launch of KL Eco City, its mega commercial project adjacent to Mid Valley".


Well, I think they are terribly wrong, not just wrong but terribly wrong. SP Setia was my favoured property counter from day one. Its ascendancy was halted by the UEM Land-Sunrise, and then swiftly followed by IJM Land-MRCB and then Sunway City-Sunway Holdings. There should be some "big news" in the pipeline for SP Setia. Some have whispered of something to do with Sime Property or some massive Sime Property land jv ... I think those whispers have more merit than they appear ...(read between the lines).

Gamuda, not exactly a property counter has taken the limelight yesterday. Its basically a rebalancing act after the recent stop work order on the big project up north. Ringgit for ringgit, I still prefer the upside for SP Setia and IJM Land above the rest.

NOTE: The above opinion is not an invitation to buy or sell. It serves as a blogging activity of my investing thoughts and ideas, this does not represent an investment advisory service as I charge no subscription or management fees (donations are welcomed though). The content on this site is provided as general information only and should not be taken as investment advice. All site content, shall not be construed as a recommendation to buy or sell any security or financial instrument. The ideas expressed are solely the opinions of the author. Any action that you take as a result of information, analysis, or commentary on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

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