Most global stock markets are now down for the year by 2-6% with the notable exception of Tokyo. The falls were triggered by two events - China's credit tightening of bank credit and President Obama's proposed new rules for banks. In an interview with some journalists yesterday, I was asked whether the Bull rally was over and what was my strategy now. I thought I would share my views in this posting.
The declines of the last week were all driven by policy changes - credit tightening in China is likely to be followed by other countries especially those in the EU and US. President Obama's changes for US banks seems vague and unclear. Both come on the back of clear signs of a Global economic recovery albeit modest and also a real recovery again albeit modest in corporate earnings as evidenced by the guidance for revenue growth in 2010. There are now shortages in components in certain segments of the electronics sector probably from an absence of new capacity and a consolidation of capacity from the crisis of 2009. So a gradual removal of fiscal stimulus and a raising of interest rates from near zero levels is to be expected especially when most economies in Europe have national debts to GDP in excess of 80%.
President Obama's proposal for banks seems to be politically motivated following the democrats defeat in Massuchussets. We also have the re-election of Bernanke as Fed Chairman so a hawkish stand on US banks which are viewed by the US public as the institutions that brought this economic crisis to the US and the world economy is not unexpected. I can compare the vagueness of Obama's statement to the statement made by Tim Geithner when he first announced his bank rescue plan for the US. The markets did not like the vagueness and pushed global indices to their March 2009 lows but rebounded strongly when the plans were more concrete. We have a similar situation now. The policy is vague, we dont know if it can get through congress and even if it does we dont know the actual implementation period for such a policy. As of now a lot of political rhetoric but little substance.
Net effect of the uncertainty - a rise in risk and market volatility (see chart of the Vix below).
I think this correction provides an excellent buying opportunity as stock markets are underpinned by improving economies and corporate earnings. The main risk is the removal of excess liquidity from credit tightening and possibly new legislation from the Obama plan (if and when it gets implemented). So better avoid stocks (especially blue chips) which are trading at high PERs if these are not backed by strong earnings growth.
The technical picture of the STI Index shows a nominal breach of the 50-day moving average. This has happened many times before in the last 12 months. A more important breach would be the 100-day moving average which could point to some support at 2500.
The sectors that seem to be seeing a better turn around and are still on undemanding valuations would be electronics, construction and high end property. So keep these in view when you do your bottom fishing/bargain hunting. Meanwhile until we get more clarity from Obama and his Merry men - expect more volatility and maybe even a rise in the Vix above the 30 level.