Tuesday, May 29, 2007

External Shocks

If we were to ignore the China equity markets (cannot read it anymore), the rest of the global equity markets are at a see-saw stage. Generally the undertone is still bullish, awaiting further signals from a number of US economic figures to be released towards the end of this week. All said, bulls and bears seem to have struck an understanding, and most equity markets are in a "safe" territory" (no comment on Chinese equities). Hence it is highly likely that any correction will be due some external shock to the global economy. That is very hard to grasp or discount properly. Due to the inter-connectedness of all markets nowadays, investors must constantly assess the probability of external shocks to the financial system. Just because its external, it is harder to predict, but its there.

Equity markets can discount future earnings; they can draw trendlines for PE ratios over the years and projected overselling and overbuying levels; you can incorporate the interest rate trends vis-a-vis earnings growth; even trends in commodities and soft commodities - but how do you incorporate external shocks to the equity model? Which was why the examples of external shocks can be debilitating. The February selldown by Shanghai on a silly rumour was felt from Tianjin to Timbuktu to Tanjong Malim. The US housing markets' weakness was NOT an external shock but a exaggeration of a fundamental economic factor. The yen carry trade was an external shock factor, which was exaggerated by the bears. Hence, every quarter it would be prudent to highlight the possible external shocks in the coming months on the global equity markets. As we cannot quantify properly, I can only do a guesstimate on the financial impact: $$$$$ being the most disastrous and $ having minimal financial negative impact.

a) Shanghai/Shenzen meltdown - a meltdown being a correction of at least 20%-30%. It will hit HKSE harder than most due to follow-on effects. $$$
b) A sharp correction in USD - the likelihood is there as a response to the yuan and to redress the deficit; and/or China diversifying away from holding USD; a reversal of the yen carry trade compounding matters. $$ (In fact, I think there could be more benefits for the overall global equity scene with a sharp USD depreciation over the longer term)
c) Oil price shooting above US$70 - nationalisation in South America and uncertainty in Nigeria. $ (if it goes above US$90, then we can be scared)
d) Sudden selldown in emerging markets currency and/or stocks - all it takes is one country to take a tumble, it could be Turkey, Brazil, South Africa ... and it could have repercussions on all emerging markets. $$$$
e) Hedge funds implosion - the markets should be able to absorb a few of them failing without too much worry, but more regulations are needed on this asset class. $$
f) Private equity implosion - will be triggered by a sharp succession of interest rate increases because their funding for deals depend on low rates, but should be able to see this from afar as it will not be an overnight thing. $$$$
g) Risk aversion mentality - Right now global investors still have a normal investing attitude but a risk aversion attitude will sharply lower all valuations, especially in emerging markets. Factors that could cause that: US bond yields rising above 5%; major default in an emerging market; plus any of the above happening will increase risk aversion mentality. $$$$


yusuf said...

dear selvadurai, salvatore, see wah toh and che wah tok'

i find ur writing most lucid in explaining the international markets but isnt the global being funnelled by the cheap jap interest rates, china flush reserves that bouyed the US treasuries and american market's appetite to whet on expensive items. So as long as the three pillars of jokers play their role there will not be any hiccup but then aint it too obvious that one of these days the over the counter market on derivatives will likey be the catalyst for the collapse of the wolrd market and its coming.

doozy said...

so, we are see bear stern going down. the hedge fund implosion is coming ahead now.

let's see if there will be a flesh round of dominos. last seen was shanghai scare. since, we have not seen that but a raging bull.

are we seeing the bull taking a break for a while?