Don’t Wait for Clear Skies In The Markets!

Markets have been quietly recovering, but few seem to be aware of it. Volumes on the Singapore stock exchange are very low, and there have not been any major announcements that would lead people to think: “Yes, the worst is over and markets are going up from this point on!”

However, over the last few weeks, markets have been recovering (see Chart 1). The main reason is that most of the bad news have already been factored into the equity markets. Furthermore, there are increasingly good bargains to be found. So, rather than waiting for clear skies before venturing back into the markets, it is better to take the longer-term view that a recovery will eventually come, and to pick up the good bargains now, in anticipation of that recovery.

Table1: Market Performances of Asian Equities Since Dip (in SGD terms)

Source: Bloomberg

Chart 1

Source: MSCI, Figures are expressed in SGD terms.

As table 1 shows, many Asian markets (with the exception of Malaysia) have risen by 15% or more over the last few weeks. Yet, the economic backdrop behind this rise has been largely the same as that which drove markets down since October last year. The US economy is still going into a recession, if it isn’t already in one already. Large banks from Europe and US alike have still been declaring billions of dollars worth of write-downs due to sub-prime loans. Oil prices continue to climb higher and higher. And the US property market continues to fall further.

Old News Is Simply That – Old News

The key thing is that all these are now old news now. The markets have largely factored in the weak US economic data. For instance, even when first quarter GDP for the US was reported at a weak 0.6% annualized quarter-on-quarter growth for the first quarter of 2008, the market was actually relieved that it wasn’t in the negative territory that many had fully expected.

The Fed’s actions have created a certain floor for US financial firms. By making the move to bail out Bear Stearns, the Fed has effectively declared that there are certain banks and financial institutions that are too big to fail. While this is likely to pave the way for greater regulation of US financial markets, it at least bolsters the public’s confidence in US financial institutions, in the immediate short term.

Asia’s economic data releases so far has also shown that despite a significant slowdown in US growth, this has not had as heavy an impact on Asia’s growth as many feared. For example, Singapore’s first quarter GDP registered a growth of 7.2% year-on-year, a very high figure in the backdrop of just 2.5% year-on-year growth from the US during the same period (which is one of Singapore’s biggest export markets). And Singapore job creation in the first quarter was even higher than in the fourth quarter of 2007, at 68,000.

We believe that even if the US did not fall into recession in the first quarter, it will likely do so in the second quarter this year. However, increasingly, investors are no longer having any high hopes of the US economy and most are now expecting a US recession to happen. This is the reason why we believe that the market has factored in most of the bad news at this point in time.

I am reminded of something similar to this happened many years ago in 1990, during the Savings and Loans crisis. At that time, US financials also went into a tail-spin, while Asia’s growth remained strong. During that period, Asian markets, after declining more than the US market, staged a very strong rebound shortly after it bottomed out. I believe we are in a similar situation. The key thing is that one shouldn’t wait until there are clear blue skies again, and when bad news stop coming in before going back into the market because by then, the market would have already risen substantially. As table 1 shows, even in the absence of any particularly good news, there has been a 15% or more recovery in markets in the last two months.

Another key reason why it would be a good time to take the plunge back into markets now, rather than waiting, is that news on the economic front can hardly get any worse. When the full picture of the financial mess that US initially emerged, there was the sinking realisation that this would spell very bad news for the US economy. There was shock and markets reacted negatively to the bad news.

However, these are all old news. Higher oil prices? US economy going into a recession? Financial turmoil and a deep housing market slump in the US? Investors have heard and seen all these splashed across the news headlines repeatedly over the last few months. For investors to be any more shocked (than they already are) at the state of the US economy, the situation would need to worsen drastically!

And initially, there was the assumption that the slump in the US economy would definitely hit Asian economies, and badly too. Asian markets actually fell more than the US markets from the start of the year to March 2008. However, as Asian economies continued to grow despite the stumbling US economy, investors gained increasing confidence that Asia might be spared the worst this time round. Hence, the good bargains would likely to be in Asian markets because the initial fears over the US contagion has brought down Asian markets to attractive levels of valuations, yet economic growth and earnings growth remain very resilient.

Bargains in Asian Markets & Financial Sectors

The valuations of most Asian markets are still very attractive. Markets like Singapore are trading at 14.2X 2008 price-to-earnings (PE) ratio. Thailand is trading at 12X 2008 PE, and Taiwan is trading 14.7X 2008 PE. Adding to that, Asia is still expected to generate reasonable earnings growth over the next three years. Asia ex-Japan’s earnings growth is estimated to be at 9.3% and 10.1% in 2008 and 2009 respectively (figures are as at 20 May 2008). We favour Thailand, Taiwan and Singapore equity markets at this time due to their attractive valuations and robust earnings growth.

But Asia is not the only place for bargain-hunting. The US and European financial sectors, the epicenter of the ongoing financial crisis there and the originator of the sub-prime loans issue are now looking increasingly attractive from a valuations point of view. US and European financial stocks are going for a bargain right now and hence, global financial funds that have larger exposure to these financial stocks are looking very interesting now.

There are parallels to be drawn between the current financial market turmoil and the Asian financial crisis in 1997. At that time, Asian banks were sold down to very low levels as the entire sector, regardless of the financial health of the individual company, was deemed to be sick and in trouble. After the Asian financial crisis was over, the share prices of the banks that “survived” the crisis then rose tremendously, because investors realised that these were resilient and were un-deserving of being sold to the low levels that the Asian financial crisis had brought them to.

Today, we have a similar situation going on in the US and in Europe. As measured by the price-to-book (PB) ratio, many of the banks in Europe (recorded from 1996), and US are trading at near 1.3 times price to book (as at end April 2008). The last time they traded at levels lower than that was during the lows of the Savings and Loans crisis.

This means that there are bargains to be picked up there. Global financial funds, being well-diversified, would ensure that the fund manager does not put all its money into just one bank, which might later go bankrupt. The survivors of this current financial crisis would emerge stronger, and see substantial earnings growth subsequently.

What other area has been bashed down due to the sub-prime related loans issue? That other area would be high yield bonds. Again, these have been bashed down by negative association with sub-prime related debt. So, any high risk debt instrument, like high yields, are now trading at very low levels. The spreads between interest-free rates and high yields are now at their widest since 2003. Yields of US and European high yield bond funds are at around 6-7% (as at April 2008) in Singapore dollar terms. Given the extremely low interest rate environment we are in right now, this would be extremely attractive. The only thing holding most investors back is the fear that they may fall even further.

However, for those that is able to take a longer term perspective. These times represent a very good time to pick up such high yield bond funds cheap. Because when the US and European economies start to recover again, and when the worst of the sub prime related fears have blown over. Investors will start to realize that many of these high yield bonds should be worth more and that the yields are very high. Such a recovery would mean that not only are the investors who scooped up such high yield bond funds getting a good yield, they will also benefit from capital gain when the prices of high yield bonds recover, which would accordingly cause high yield bond funds to go up in value.

Conclusion

While many investors may still be waiting for the ‘clear skies’ signal before they venture back in, that is not necessarily the best strategy in the current situation. The best gains are made from going into markets when they are low. And the point in time when markets are low, is when bad news are prevalent – not when there are clear blue skies all around. Waiting for a clear indication that the worst is over, and that markets are on a firm track upwards may mean not participating in a large part of the recovery in markets when it happens. So, it is better to take a long-term view Volatility will always be there and can be expected to persist, especially in the short term. Don’t be afraid of such volatility, for it is usually during such bad times when the best bargains are to be found.

Wong Sui Jau (CFP) is the General Manager of Fundsupermart.com Pte Ltd, a division of iFAST Financial Pte Ltd.

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