Thursday, August 27, 2015

This is just the beginning...

Market participants rode through one of the scariest financial roller-coasters in the past two weeks. In Singapore some stocks were down 7-8% in a single day, cumulatively losing 15-20% in one week. In the US, things were even more dramatic, some stocks when through 20% intra-day swings. Then today everything bounced, as if nothing happened. It was really quite unsettling. Most of us would be asking, "Why? Why? What happened? What now?". Sadly, at this juncture, there are no good answers. That was what happened during the first two weeks for the Lehman crisis.

Markets are a bit like earthquakes. Shifts in tectonic movements cause tension to build up and over time this would result in earthquakes or eruptions, usually once every 10 to 20 years, we see a mega earthquake around the same vicinity. There was Kobe in 1995, then Fukushima in 2011. In the financial markets, we see the same phenomenon. Tension builds up over time as investors feel comfortable and buy up everything, at high valuations until some catalysts trigger a major sell off.

It was said that the Global Financial Crisis (GFC) would be a trilogy. We saw the original crisis created when Lehman collapsed, which then shifted to Europe with the Greek saga and now coming to Asia with China. This pattern resulted because of the measures brought in to stabilize the system. When the GFC first occurred, Europe unleashed its liquidity to save the banks, the Greeks took advantage of that and over leveraged and its tragedy unfolded. Then China dumped 4 trillion RMB to save its economy and led to over-capacity in every form: ghost towns, roads to nowhere, idling steel plants, you name it. 

Now all the death stars are aligned, we just saw a crazy stock market boom in China from late 2014 to June 2015, US stocks were at all-time high valuations after months of rally and Europe started to feel euphoric again. Things are really ripe for a collapse. As usual, nobody saw this coming. Because the future is unpredictable. We simply cannot tell. But based on past experiences, we can guess what is more likely to happen. The guess today is this is just the beginning of a more major collapse.

Why so? The following chart might give us some clues. 

STI's Price, PE and Dividend Yield

The above is a chart of the STI from 2005. The price movement is in white and brown bars give the PE over the years and the purple bars show the dividend yield. So, it is now clear that even with the heart wrenching crash last week, STI's PE is still high at 12.5x compared to its own history and dividend is not at all attractive at 3.5%. Even when compared to the Greek crisis in 2011, when PE was 10x and dividend rose to 4.5% we cannot say we are close to that kind of level. 

Hence it is more likely that as the global markets continue to cough and sneeze, STI will see more bloodshed. We could be heading below 2,500 before there is any stabilization. I really don't think STI would revisit Lehman lows of 1,500 and dividend going to 7% given that the global economy is not at the brink of collapse as it was during Lehman. 

Those were crazy days, it was said that the world as we knew it would stop functioning. Fiat currencies would mean nothing and all the zeros in our bank accounts would literally mean zeros. Imagine life savings gone! Those with land or livestocks could be king because they could grow their own food or live off their animals. This is not a joke, take a moment to think about how the world could have changed.

Well, that didn't happen. But you can read about it in, "What Could Have Happened".

Now we see the alternative scenario playing out, the crisis had become a trilogy and this final installment is in front of us now. It is not a bad thing for the market to fall another 20-30%. It would be a great opportunity to buy those really great franchises we talked about and also to reconfigure our portfolios to better names. This is a rare chance in almost a decade. 

Again, this is not a prediction. All we are saying is that there is a high probability that the markets will have to fall another 20-30% before things are sorted out. But it could also well be that markets again shrug off the woes because the world central bankers decide to do another round of global QE (rather than raising interest rates in September as was talked about), and we see the tides rise again! That's low probability but to zero probability.

So buckle your seat belts, the ride is about to begin!

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