Thursday 28 Mar 2024
By
main news image

This article first appeared in Capital, The Edge Malaysia Weekly on February 12, 2018 - February 18, 2018

THE recent sharp decline and volatility in the US stock markets has frustrated US President Donald Trump. So much so, that he said in a tweet last Wednesday, “In the old days when good news was reported, the stock market would go up. Today, when good news is reported, the stock market goes down. Big mistake, and we have so much good (great) news about the economy!”

The good news Trump was referring to was the jobs report released on Feb 2, which indicated that the world’s largest economy added 200,000 jobs, beating the consensus estimate of 180,000, while the unemployment rate met expectations at 4.1%.

However, the market’s reaction to that was a 665-point, or 2.5%, drop in the Dow Jones Industrial Average to 25,520.96 points. Since then, the DJIA has whipsawed, falling to a low of 23,778.74 last Tuesday before closing at 23,860.46 points last Thursday, with stability returning only intermittently throughout the week.

Michael Kahn, a US-based chartered market technician sees the market’s decline as an overdue necessity.

“The market finally flushed out its excesses. It’s been overdue,” he tells The Edge.

Kahn attributes the drop in US markets to many factors — overvaluation, excessive speculation, overextended technical conditions, the prospects of higher interest rates and Jerome Powell taking the reins from Janet Yellen as the new chair of the US Federal Reserve.

Naturally, the drop in US markets had a domino effect on Asian markets — including the FBM KLCI, which lost 40.62 points, or 2.2%, on Feb 6, its sharpest one-day decline since Aug 24, 2015. However, Kahn does not see the drop in US markets as a precursor to a bear market.

“I think we are in a global recovery and bull market. It might be a cliché to say it, but I think commodity prices are about to break out to the upside and that, typically, is good for small markets around the world, including Malaysia,” he says.

Paul Gambles, a founding partner of Thailand-based advisory business practice MBMG Group, opines that a break significantly below a 22,000 close on the Dow Jones could be an indication of a bear market.

“I’m not convinced that this bout of volatility is more than a tantrum that could presage a much more prolonged wrestling match between agents trying to prop up the markets and forces weighing them down.

“It would require a break significantly below a 22,000 close on the DJIA as an indication that we could be further into the real bear market that is lurking somewhere in the future and could rival the great crash of 1929-1932 when the Dow fell by over 91% and heralded the Great Depression,” he says.

CIMB-Principal Asset Management chief investment officer Patrick Chang writes in a Feb 8 note to investors that Malaysia is still experiencing a cyclical turn in the economy supported by improving trade, a current account surplus and potential earnings per share upgrades, particularly in economically sensitive sectors like financials.

“Our base case is that if we do get a favourable simple majority in the upcoming general election, the KLCI should scale above 1,900. Our blue sky target on the KLCI is 2,020 points in the next 6 to 12 months.

“We would take the current market weakness to add to some of the long-term names in financials, e-commerce and cyclical sectors,” he says.

FXTM chief market strategist Hussein Sayed says that many contrarians would like to follow banker Baron Rothschild’s advice: “Buy when there’s blood in the streets.”

“As of now, I do not see any blood, but a healthy correction which has been overdue for a long time. From a valuation perspective, the forward price-earnings ratio on the S&P 500 has dropped from 20 at the beginning of the year to below 18, suggesting that prices are still expensive when compared to historic averages.

“Deciding to buy, sell or hold is a tough one in such circumstances, but if investors believe the global economy and that corporates will continue firing on all cylinders, the downside risk is likely to be limited from current levels. However, another 5% to 10% correction should not be ruled out,” he says in a Feb 8 note.

Yields in risk-free assets, such as the 10-year US treasury notes, are on the rise — touching four-year highs of 2.8411% on Feb 2. The 10-year yield was 2.824% last Thursday.

FXTM’s Hussein adds that fixed income markets have started looking attractive and if the surge in bond yields resumes, there will be more incentive to pull out from stocks into bonds.

“That is why bond markets, particularly in the US, will play a major role in how much further the correction may continue,” he says.

The pace of the rise in yields — should it reach the critical rate of 3% — could dictate the pace of the rate hikes by the US Federal Reserve. For now, the Fed’s overnight funds rate is anchored at 1.25% and 1.5%.

Volatility could remain as investors react to emotions rather than fundamentals.

“…the markets are clearly not always driven by fundamentals and, as seen in the past week or so, a number of technical factors are playing a role in driving up volatility, with potential and far-reaching collateral damage,” DBS Economics and Strategy said in a report last Friday.

The report’s authors, Taimur Baig and Ma Tieying, point to the proliferation of programme-based trading and leveraged exchange-traded funds (ETFs).

“They work well when markets are characterised by low volatility and upward momentum, but can cause a selling frenzy at the first hint of a shock, destabilising the system. Virtually nothing in the economic news flow in the past week would have warranted a sharp market correction, but it came nonetheless,” it adds.

It says that while regulators have put up a brave front amid the market volatility, they have been known to yield to market selloffs as sharp movements in rates and foreign exchange can cause real economic distress.

“Perhaps more worrying is the fact that the complexity of the global financial linkages is such that despite substantial improvements in monitoring and oversight since the 2008 crisis, unpleasant surprises pop up whenever volatility rises, as evident in the demise of a few ETFs in the past week. A return to higher volatility may have been inevitable, but the associated ride is turning out to be unpleasantly bumpy,” it says.

 

Given recent developments, should investors stay in equities?

Looking back at the performance of the FBM KLCI from 2011 to the present, the index charted a total of nine days within that period when it saw declines of more than 2%, with the latest being last Tuesday.

Interestingly, on Sept 26, 2011 (see Chart 1), the FBM KLCI saw a decline of 2.5% but in the next 12 months the index gained 21.6%. This means that investors who had taken advantage of the market’s decline in 2011 — which was mainly due to the eurozone crisis at the time — would have reaped returns ranging from 3.83% to 21.6% in the next year.

Similarly on Aug 24, 2015, the FBM KLCI saw a decline of 2.7% on concerns over China’s economy. However, within the next 12 months, the index recorded an increase of 9.8%.

Going against the grain seems to pay off, but getting a handle on sentiment may be easier said than done for most investors.

Chart 1 — which has excluded the crisis years, such as 2008 when Lehman Brothers collapsed as a result of the US sub-prime loan crisis — aims to show that even in non-crisis years, it is normal to see a 2% fall in a single trading day.

 

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.

      Print
      Text Size
      Share