So, What's Really Driving The Markets?
Getting To The Core
You have equity markets gaining every single day for more than 10 days in a row. The record for US markets was, I believe a 10 day gaining streak back in January 1989. Since then, almost 18 years later do we see a similar phenomenon. Readers of this blog will be aware that I have been bullish since beginning of 2006, and even stressed that back then, all equity markets are going into, or even already in the midst of a bull market without most people realising it.
This bull run was cemented a few years back, the believers were few, which is why the level of participation rarely got to a prolonged euphoric state. This is clearly one of the quieter bull runs. But why are we in this bull run? Why are markets all so bullish?
If you cite earnings, lowering of interest rates ... it would be yes, and a maybe respectively. There must be some underlying reason for the hooplah. I think I must have touched on this before, but its worth mentioning again:
a) bull run part of rise in "commodity prices" - prices as in most commodities, what we have for the last 4 years was a stupendous jump in commodities, when they jump and its due to demand jumps, then it will be inflationary, ... but this time around, the demand was largely due to corresponding larger jumps in productivity (e.g. outsourcing in China), thus inflationary domino effects was muted ...
b) China - the impact of China alone in the global economy has been understated. More than 60% of listed US companies have some sort of outsourced operations, directly or indirectly, in China. What that means is by doing so, it raises productivity and results in a better allocation of resources. Hence you find many US companies finding it easier to maintain or even grow margins over the last 4 years, thus translating into a happy Wall Street and stock prices. And this is not a one to three year thing, I think the outsourcing resulting in growing margins can still be pushed for at least another 3-4 years before differentials narrow to the point of negligibility.
c) private equity - the pooling of funds into private equity over the last 3 years have been outrageous. PE firms have been able to register better returns than most equity indices thus the flow of funds are continuing. The rise of PE is partly due to the brilliance of many PE managers but largely to the existence of too many staid, large but undervalued listed companies. By taking them private and recharging the batteries, many PE firms have been able to improve margins and refocus these undervalued companies, and then relist them at higher premiums. They are doing something good, but they are basically just bringing up these companies to par valuation, nothing terribly fantastic. But PE activity will cause the valuation of sectors of interest to rise, even the mere whisper of a takeover will raise valuations of similar stocks in the same industry. The effect is higher prices for all, and the number of undervalued companies will see a gradual reduction in numbers, and even the quantum of difference in undervaluation will reduce ... = higher equity prices.
d) REITs - it frees up a lot of capital, an awful lot of capital, most of which went into good hedge funds or private equity. Who buys REITs, retail yes but more so are insurance companies who now have a better way to manage risk and returns better than just bonds. So, its not a zero sum game, effectively more bondholders are switching to REITs, and sellers of REITs have been raising cash like crazy, and sometimes you don't even have to lose control of the asset. A big contributor to liquidity in the system.
e) China again - the rise and rise of China have opened up a huge market place for a lot of US and European companies. Fees, commissions, joint ventures, projects have sprung up like nobody's business - just ask the top 10 American investment banks in China, and the IPO fees they are getting. To any big corporation, previously you have a 5% market share of a 100 billion dollar industry, now you have 5% of a 130 billion dollar industry with the emergence of China as a consumer. The more successful China integrates with the international market forces, the better off will the Chinese be, and the bigger the consumption demand for global goods and services. Looking at the per capita in China, even if per capita income rises by 10% each year, there is still enough excitement to last for 10 years at least before the vicious cycle gets ugly.
f) Asia recovery from financial implosion - enough said, it took many countries at least 5 years since 1997 to get rid of the excesses, now most are just trying to get back to parity. If you remember correctly, the ringgit used to be 2.5 to the dollar in the 90s. Considering that we have gotten rid of excesses, improve productivity, reduce corruption, improve transparency... and US deficit is at even higher levels now, getting back to 2.5 is a no-brainer. But we don't want to get there too fast, we need exporters to feel comfortable. Hence Zeti has been smart enough to keep ringgit's rise in line with China's yuan. Getting to 3.3 or even 3.2 this year is a cinch for the ringgit. Export industries should relook into their margins and productivity seriously before screaming at eroded earnings - the ringgit has been helping you buggers for far too long. If you cannot operate at 3.0 to the dollar in 12 months time, you better just fold your business cause you cannot compete in the global markets. To rely on a weak ringgit to compete means you have a very weak business model and not much competitive edge. A country will depress its currency to gain export dollars to recover from a crisis/weakened state, its over now. We have to move up the ladder.
In conclusion, the recent gains may seem frothy but its not all hot air. Plus the fact that markets tend to be very bullish anyway in the FIRST QUARTER, I do believe the second and third quarters will be more volatile with sharp downside bias before perking up in FOURTH QUARTER again. Its really difficult to see the market correcting 10% even from here, any pullbacks will be in the region of 2-3% tops. On valuations, prices are high but not excessive levels yet to warrant a sharp correction.
In fact, the risks to all equity markets are largely EXTERNAL rather than within the markets itself. I see EXTERNAL factors being the largest risk poser, for example: a collapse of a small brokerage in China triggering a huge loss in some regional bank; unexpected austerity measures in China's property market (e.g. 50% deposit for purchases) triggering a sharp sector correction and mood change; Republican and Democrat parties elevate their differences and stalling on issues/laws progression; pockets of violence boils over globally requiring international attention; H5N1 outbreaks or new strains of the virus in parts of Asia (again); US dollar collapsing by 5% in a couple of days triggering massive capital flow changes (if that happens, the ringgit could go from 3.5 to 3.1 overnight, and that may trigger a collapse in KLSE as people perceive no more upside for ringgit and would want to lock in gains and leave) ... So, even when you can see no risk, there are still risks.
Getting To The Core
You have equity markets gaining every single day for more than 10 days in a row. The record for US markets was, I believe a 10 day gaining streak back in January 1989. Since then, almost 18 years later do we see a similar phenomenon. Readers of this blog will be aware that I have been bullish since beginning of 2006, and even stressed that back then, all equity markets are going into, or even already in the midst of a bull market without most people realising it.
This bull run was cemented a few years back, the believers were few, which is why the level of participation rarely got to a prolonged euphoric state. This is clearly one of the quieter bull runs. But why are we in this bull run? Why are markets all so bullish?
If you cite earnings, lowering of interest rates ... it would be yes, and a maybe respectively. There must be some underlying reason for the hooplah. I think I must have touched on this before, but its worth mentioning again:
a) bull run part of rise in "commodity prices" - prices as in most commodities, what we have for the last 4 years was a stupendous jump in commodities, when they jump and its due to demand jumps, then it will be inflationary, ... but this time around, the demand was largely due to corresponding larger jumps in productivity (e.g. outsourcing in China), thus inflationary domino effects was muted ...
b) China - the impact of China alone in the global economy has been understated. More than 60% of listed US companies have some sort of outsourced operations, directly or indirectly, in China. What that means is by doing so, it raises productivity and results in a better allocation of resources. Hence you find many US companies finding it easier to maintain or even grow margins over the last 4 years, thus translating into a happy Wall Street and stock prices. And this is not a one to three year thing, I think the outsourcing resulting in growing margins can still be pushed for at least another 3-4 years before differentials narrow to the point of negligibility.
c) private equity - the pooling of funds into private equity over the last 3 years have been outrageous. PE firms have been able to register better returns than most equity indices thus the flow of funds are continuing. The rise of PE is partly due to the brilliance of many PE managers but largely to the existence of too many staid, large but undervalued listed companies. By taking them private and recharging the batteries, many PE firms have been able to improve margins and refocus these undervalued companies, and then relist them at higher premiums. They are doing something good, but they are basically just bringing up these companies to par valuation, nothing terribly fantastic. But PE activity will cause the valuation of sectors of interest to rise, even the mere whisper of a takeover will raise valuations of similar stocks in the same industry. The effect is higher prices for all, and the number of undervalued companies will see a gradual reduction in numbers, and even the quantum of difference in undervaluation will reduce ... = higher equity prices.
d) REITs - it frees up a lot of capital, an awful lot of capital, most of which went into good hedge funds or private equity. Who buys REITs, retail yes but more so are insurance companies who now have a better way to manage risk and returns better than just bonds. So, its not a zero sum game, effectively more bondholders are switching to REITs, and sellers of REITs have been raising cash like crazy, and sometimes you don't even have to lose control of the asset. A big contributor to liquidity in the system.
e) China again - the rise and rise of China have opened up a huge market place for a lot of US and European companies. Fees, commissions, joint ventures, projects have sprung up like nobody's business - just ask the top 10 American investment banks in China, and the IPO fees they are getting. To any big corporation, previously you have a 5% market share of a 100 billion dollar industry, now you have 5% of a 130 billion dollar industry with the emergence of China as a consumer. The more successful China integrates with the international market forces, the better off will the Chinese be, and the bigger the consumption demand for global goods and services. Looking at the per capita in China, even if per capita income rises by 10% each year, there is still enough excitement to last for 10 years at least before the vicious cycle gets ugly.
f) Asia recovery from financial implosion - enough said, it took many countries at least 5 years since 1997 to get rid of the excesses, now most are just trying to get back to parity. If you remember correctly, the ringgit used to be 2.5 to the dollar in the 90s. Considering that we have gotten rid of excesses, improve productivity, reduce corruption, improve transparency... and US deficit is at even higher levels now, getting back to 2.5 is a no-brainer. But we don't want to get there too fast, we need exporters to feel comfortable. Hence Zeti has been smart enough to keep ringgit's rise in line with China's yuan. Getting to 3.3 or even 3.2 this year is a cinch for the ringgit. Export industries should relook into their margins and productivity seriously before screaming at eroded earnings - the ringgit has been helping you buggers for far too long. If you cannot operate at 3.0 to the dollar in 12 months time, you better just fold your business cause you cannot compete in the global markets. To rely on a weak ringgit to compete means you have a very weak business model and not much competitive edge. A country will depress its currency to gain export dollars to recover from a crisis/weakened state, its over now. We have to move up the ladder.
In conclusion, the recent gains may seem frothy but its not all hot air. Plus the fact that markets tend to be very bullish anyway in the FIRST QUARTER, I do believe the second and third quarters will be more volatile with sharp downside bias before perking up in FOURTH QUARTER again. Its really difficult to see the market correcting 10% even from here, any pullbacks will be in the region of 2-3% tops. On valuations, prices are high but not excessive levels yet to warrant a sharp correction.
In fact, the risks to all equity markets are largely EXTERNAL rather than within the markets itself. I see EXTERNAL factors being the largest risk poser, for example: a collapse of a small brokerage in China triggering a huge loss in some regional bank; unexpected austerity measures in China's property market (e.g. 50% deposit for purchases) triggering a sharp sector correction and mood change; Republican and Democrat parties elevate their differences and stalling on issues/laws progression; pockets of violence boils over globally requiring international attention; H5N1 outbreaks or new strains of the virus in parts of Asia (again); US dollar collapsing by 5% in a couple of days triggering massive capital flow changes (if that happens, the ringgit could go from 3.5 to 3.1 overnight, and that may trigger a collapse in KLSE as people perceive no more upside for ringgit and would want to lock in gains and leave) ... So, even when you can see no risk, there are still risks.
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