Monday, August 08, 2011

Stick Market Turmoil - fear as opportunity?

As I write this, the STI index has fallen more than 100 points on each of the past 2 trading sessions. The Dow Jones industrial has fallen on 9 out of 10 days (??) including one disastrous plunge of more than 500 points  As we look forward to the next trading session tonight, the futures show that the DOW will be opening more than 200 points lower.  The S&P downgraded USA sovereign debt from AAA to AA+. The global economy sits on the verge of another recession and the European crisis threatens to spread and engulf the rest of the world. If you ask me, nothing looks good for stocks in this environment - nothing is going right for the stock market......and nobody dares to buy stocks given the head winds ....however.....

I think stocks will head up - at least in the short term.  I may be completely wrong and I'm not a profesisional financial advisor so take what I say with a pinch of salt....and please don't act on this blog posting.

Very often stocks plunge for good reasons, some times they fall because of irrational fears and rebound quickly. This time it is worries about the crisis in Europe and the global slowdown that has caused stocks to fall very sharply - at least this is what we have been told. It is a little strange because the slowdown has signs 2-3 months ago and investors did not seem too worried about it - many thought the slowdown was temporary and the economy will pick up in the 2nd half. Now we in the 2nd half, investors suddenly realise the temporary soft patch seem to be not so temporary. They suddenly started selling stocks and have been selling non-stop for the last 10 days. They are fearful of the US slow down, the US debt ceiling mess, the European crisis and now the fret over the US debt downgrade. If you're looking for reasons to sell stocks, there are plenty....so why do I think stocks will go up in the short term?

If you look at company earnings in the US, they are very good. Stock market valuation is also very cheap measure using value metrics such as price to book, free cash flow and P/E ratios. This is rather surprising given the economic slowdown. The good corporate earnings is due mainly to the weak US$ that allowed US corporations with overseas markets to do very well. Cheap stock valuation however is not the reason why I think stocks will soon rebound in the short term. Just that the rebound is not held back by poor corporate results. These cheap valuations can be a value trap as Robert Shiller explained that US corporate earnings right now is the highest ever as a % of GDP and he believes cannot be sustained over a long period.

The reason why I think stocks will rebound soon is the crowd psychology. The market recently has been bombarded by "headlines news" such as news about the US debt ceiling debts, news about S&P downgrade of US debt, news about the trouble with Italy and Spain - Greece is yesterday's basket case and somewhat neutralised. I can't think of a period other than 2008 when there has been such a concentration of "shocking" bad news. While the European crisis and global slowdown are serious problems, they can't keep generating shocking news from these - the Europeans have another plan to kick Italy's problem further down the road and the global slowdown is just that a deceleration of the global economy - it may be a impactful and shocking if it occurs suddenly but this has been dragging on for months.. The latest "shock" is the downgrade of US sovereign debt - with every shocking news investors dump their stocks ....day after day for the past 2 weeks. The fear level among investors measured by what is known as the VIX index is at its highest in the past 12 months.

The VIX roughly measures the price investors are willing to pay to hedge their stocks against further falls. When the VIX is high investors are very fearful - you can see the VIX has risen to the highest level in 12 months exceeding the high achieved when investors became paranoid about the nuclear crisis in Japan. It took a sequence of shocks to get the fear level among investors to this extreme levels.

The basic notion of investing in stocks to take small ownership of  a business to collect your share of profits in the business is completely lost and overrun by investor fears. At some point, CNBC will run out of shocking news to play up and investors' fears will reach a level that cannot be exceeded. The shocking downgrade of US sovereign debt is perhaps that moment.

The rebound comes when some of the fear subside and investors remember that companies reported great earnings for the last quarter and dividend yield are historically high relative to the interest rates ....Tonight the Dow Jones index look set to open sharply lower....lets see how it goes from here. So are we going to get a bounce soon? I think so....

8 comments:

Anonymous said...

It will rebound when they announce QE3.

Anonymous said...

Even Marc Faber thinks we'll see an intermediate bottoming these couple of days. Yeah, when Big Ben announces QE3 these few days, the markets will chiong up for next couple of months. But euphoria will not last too long. Stocks will become volatile going into the end of 2011 and into 2012. High possibility of crash next year.

Amused said...

This is a very uncertain time. Some euro countries are still to fall. So don't get in too early.

Keep your gold.

Anonymous said...

There will eventually be a rally.

The only question is whether it's a buying opportunity or another opportunity to short sell into strength.

Just love the stockmarkets.

It's the only departmental store where the customers all rush out of the store whenever a sale comes on!

Anonymous said...

This rebound is the opportunity to sell. We've only just began remember?

Anonymous said...

Ur beloved Obama just sent Dow further to -600+.
Do u miss the bush levels of incompetence yet?

Anonymous said...

Hope it goes on for another 2-4 months.. then we will see the skeletons.

Just like a tsunami.. first the tide goes out and the rocks, starfishes are visible... second, the tide rushes back in with this humongous wall of water..

See you all up in thar hills bro!

kalpeshmmaniar said...

S&P has downgraded US debt, this has created panic in the markets, but the question is should we take S&P seriously when these credit rating agencies have proved that their understanding about economies is indeed poor.

Remember, it is the same S&P that gave AAA rating to mortgage backed securities in 2005-2007 and we all know what happened after that, so I guess its time to be bullish when S&P, Goldman and the likes become bearish on the world. please visit http://www.kalpeshmaniar.com for accurate forecasting