Unnerving
By Yiannis G. Mostrous
FALLS CHURCH, Va.–Markets move in mysterious ways. Just last week I wrote that the near-total absence of bearish voices was reason for investors to be cautious.
Those comments were made while Asian markets were making new highs, and I hoped to highlight the danger this reality was creating in a risk-seeking environment. And yesterday the Chinese market gave its first scare in more than six months by dropping 9 percent in a single day. The rest of Asia followed suit.
The US also declined substantially as investors tried to adjust their market positions by taking profits off the table. And given the market’s run since July 2006, there are a lot of profits to be taken.
The S&P 500 Index was up almost 18 percent from its low last summer, and even after yesterday’s selloff, it’s still up double digits. It seems that the desire to reduce risk hits all investors at the same time.
As a result, we experienced an overnight transformation in the global investing environment, a move from extreme greed to alarming levels of fear.
But for a market–China–that enjoyed a 50 percent rise in three months, a correction like this shouldn’t merely have been expected; it was also necessary. Chinese authorities have made it clear that they’re trying to cool down not only certain parts of the economy but also the stock market.
The latest warning came toward the end of 2006 when Cheng Siwei, vice chairman of the Standing Committee of the National People’s Congress, warned investors against “blind optimism” in relatively underdeveloped local capital markets.
The People’s Bank of China (PBoC), in its quarterly Monetary Policy Execution Report released in early February, acknowledged the fact that its measures to slow loan growth and improve loan structure–a particularly worrisome part of the Chinese economy–have started to work.
I look favorably on responsible government actions–such as those we’ve seen India and, increasingly, in China–to rein in exuberance. Although the results aren’t guaranteed, and may cause short-term pain, the long-term effects are unquestionably bullish for the region’s economies and markets.
When it comes to the Chinese market, I’ve been quite negative overall. As I noted here not long ago:
These are the stocks that suffered the biggest declines off recent highs, ending the day anywhere between 10 percent and 25 percent from those levels.
Profit-Taking
What we saw Tuesday was profit-taking, rather than a reaction to poor global economic data or market fundamentals.
As I noted last month:
I expect that long-term readers have indeed taken some profits off the table and that newcomers have diversified their selections.
The Portfolio also has significant exposure to Singapore. My view here remains unchanged:
As for the global economy, I maintain the view I expressed last week:
The US economy will slow to a sub-2 percent annualized growth rate during the first half of the year.
A look at the Organization for Economic Cooperation and Development (OECD) leading indicators shows that growth rates in developed economies should start strengthening around the middle of 2007. Keep in mind that OECD leading indicators are constructed to anticipate industrial production growth cycles by six months.
The OECD leading indicators for the G-7 economies seem to be bottoming, although some near-term weakness should be expected.
Source: Bloomberg
The above data is consistent with the signal from the OECD leading indicators for the US, which appear to have bottomed around October.
Source: Bloomberg
At the same time, inflation expectations in the US continue to drift lower. The following chart is the Economic Cycle Research Institute’s (ECRI) future inflation gauge for the US. It continues to roll over, indicating that inflation may prove to be less of a threat to the markets than is commonly believed.
Source: Bloomberg
Although a total economic collapse that pushes the global economy into a deep recession (that could endure through 2008) can’t be ruled out, my view remains more benign–though not quite upbeat–on the economy’s health for 2007.
Portfolios
I explored the potential for a big market correction in Asia in last week’s issue, At A Premium. Given that for the time being there’s no clear view of the market’s wishes–perma-bear arguments aside–no action will be taken when it comes to the Portfolios.
Portfolio gains to date are substantial; it can withstand a correction. If anything develops to the contrary, I’ll issue a Flash Alert, as I did under similar circumstances nine months ago (see SRI, 15 May 2006, Silk Road Investor-Flash). I managed to get it basically right then, but please note that perfect timing isn’t my greatest strength.
Fresh Money
Malaysia, South Korea, Singapore and Japan (in that order) are the markets in Asia where investors who wish to allocate capital should look for opportunities.
FALLS CHURCH, Va.–Markets move in mysterious ways. Just last week I wrote that the near-total absence of bearish voices was reason for investors to be cautious.
Those comments were made while Asian markets were making new highs, and I hoped to highlight the danger this reality was creating in a risk-seeking environment. And yesterday the Chinese market gave its first scare in more than six months by dropping 9 percent in a single day. The rest of Asia followed suit.
The US also declined substantially as investors tried to adjust their market positions by taking profits off the table. And given the market’s run since July 2006, there are a lot of profits to be taken.
The S&P 500 Index was up almost 18 percent from its low last summer, and even after yesterday’s selloff, it’s still up double digits. It seems that the desire to reduce risk hits all investors at the same time.
As a result, we experienced an overnight transformation in the global investing environment, a move from extreme greed to alarming levels of fear.
But for a market–China–that enjoyed a 50 percent rise in three months, a correction like this shouldn’t merely have been expected; it was also necessary. Chinese authorities have made it clear that they’re trying to cool down not only certain parts of the economy but also the stock market.
The latest warning came toward the end of 2006 when Cheng Siwei, vice chairman of the Standing Committee of the National People’s Congress, warned investors against “blind optimism” in relatively underdeveloped local capital markets.
The People’s Bank of China (PBoC), in its quarterly Monetary Policy Execution Report released in early February, acknowledged the fact that its measures to slow loan growth and improve loan structure–a particularly worrisome part of the Chinese economy–have started to work.
I look favorably on responsible government actions–such as those we’ve seen India and, increasingly, in China–to rein in exuberance. Although the results aren’t guaranteed, and may cause short-term pain, the long-term effects are unquestionably bullish for the region’s economies and markets.
When it comes to the Chinese market, I’ve been quite negative overall. As I noted here not long ago:
The China [bearish] argument remains a more-convincing one. It’s well known that that excess supply of capital–a problem afflicting China–leads to bad investment choices and, eventually, a readjustment period.
I don’t know when this adjustment will take place, but I’m well aware of investors’ seemingly insatiable appetite for Chinese exposure. My advice is to avoid financial stocks (banks, insurance, etc.) in China.
These are the stocks that suffered the biggest declines off recent highs, ending the day anywhere between 10 percent and 25 percent from those levels.
Profit-Taking
What we saw Tuesday was profit-taking, rather than a reaction to poor global economic data or market fundamentals.
As I noted last month:
Although the view may be beautiful from the rooftop, the fact of the matter is that Asia will once again be at the center of liquidation activity when investors decide–or are forced–to take profits.
Tactically, this is the reason why time was spent here during the last four weeks booking profits, either through outright stock selling or through simple profit-taking (i.e., leaving the initial investment intact).
I expect that long-term readers have indeed taken some profits off the table and that newcomers have diversified their selections.
The Portfolio also has significant exposure to Singapore. My view here remains unchanged:
[T]he Singapore story is intact, although investor worries regarding a potential pullback are understandable and appreciated. Note that in the context of a synchronized selloff, profits will be taken from the big winners. Singapore is home to many of them.
As for the global economy, I maintain the view I expressed last week:
I still expect a global economic slowdown to happen this year, but there’s no conviction of a US-led global recession outcome. The latter is mentioned because there’s been talk–from serious analysts–that 2007 will be the year that a real estate-based recession will take place in the US eventually affecting the global economy and markets.
The US economy will slow to a sub-2 percent annualized growth rate during the first half of the year.
A look at the Organization for Economic Cooperation and Development (OECD) leading indicators shows that growth rates in developed economies should start strengthening around the middle of 2007. Keep in mind that OECD leading indicators are constructed to anticipate industrial production growth cycles by six months.
The OECD leading indicators for the G-7 economies seem to be bottoming, although some near-term weakness should be expected.
Source: Bloomberg
The above data is consistent with the signal from the OECD leading indicators for the US, which appear to have bottomed around October.
Source: Bloomberg
At the same time, inflation expectations in the US continue to drift lower. The following chart is the Economic Cycle Research Institute’s (ECRI) future inflation gauge for the US. It continues to roll over, indicating that inflation may prove to be less of a threat to the markets than is commonly believed.
Source: Bloomberg
Although a total economic collapse that pushes the global economy into a deep recession (that could endure through 2008) can’t be ruled out, my view remains more benign–though not quite upbeat–on the economy’s health for 2007.
Portfolios
I explored the potential for a big market correction in Asia in last week’s issue, At A Premium. Given that for the time being there’s no clear view of the market’s wishes–perma-bear arguments aside–no action will be taken when it comes to the Portfolios.
Portfolio gains to date are substantial; it can withstand a correction. If anything develops to the contrary, I’ll issue a Flash Alert, as I did under similar circumstances nine months ago (see SRI, 15 May 2006, Silk Road Investor-Flash). I managed to get it basically right then, but please note that perfect timing isn’t my greatest strength.
Fresh Money
Malaysia, South Korea, Singapore and Japan (in that order) are the markets in Asia where investors who wish to allocate capital should look for opportunities.