Hindsight Harry

Easy to explain the past, hard to predict the future. Fundamentals... good. External risks have been mentioned before, but the gravity of the correction caught most, including myself, by the balls... and being yanked at the same time! Looking back now, every commentator would be a genius, so instead let's try and make more sense of it. The exaggerated selloff was based on the following factors:

1) No meaningful correction for all equity markets since late 4Q2006 (9/10)

2) Problems in the US subprime mortgage market (4/10)

3) Reversal of yen carry trade (6/10)

4) Large imbalances in Central and Eastern Europe (2/10)

5) Geo-political risk due to the concerns about Iran nuclear program (2/10)

6) Pricing in of risk into equities (9/10)

7) Hard landing for US economy (5/10)

8) China sneezes (2/10)

The ratings given are my view on their role in the current correction phase for equities. When markets rise, no one really bothered searching for reasons of the hows and whys. But when they fall, my god, we all need reasons? In scrambling for the nearest, most plausible reason, we lump one and all into our theory to explain away our fears and disappointment. However, not all reasons are created equal, some are more hype and tripe.

1) Self-explanatory.

2) Take the US subprime market, yes there are problems. Honkers & Shankers must be given loads of credit for being almost the first big bank to highlight the problem. Merrill Lynch calls for a sell on HSBC but I think its a very good buying indicator for HSBC. A bank that does not hide and manages risk astutely, makes early calls and cuts losses before gangrene sets in, deserves kudos and premium points. While there are problems in the subprime market, it is but a very small portion of the overall lending market. It is called subprime for a reason, it is not prime! Things not prime having problems is normal. But when markets fall and you go around looking for culprits, its a convenient fodder to stoke the embers of fears.

3) Its not just the yen carry trade thats creating potential problems but als swiss carry trades. Liquidity levels continue to be enormously accommodative, driven by high borrowing due to low interest rates. The Euro M3 money supply is growing at a 9.8% annual clip, its fastest in 17-years! Two of the biggest suppliers of easy money are BOJ and the Swiss National Bank. Whe you set lending rates so low, what do you expect investors to do? You know the story about the girl who climb trees and do not wear panties ... An estimated US$330 billion of carry trades in yen and Swiss francs are swirling around the global markets. BOJ lends at 0.5% while the Swiss lends at 2%, but I am still largely unconvinced that there is substantive unwinding as the differentials are still intact. In fact next week the ECB may even hike its interest rate further, thus reinforcing the differentials even more. In fact once things stabilise, I would expect even more to join in the yen and swiss carry trade now that players will get an even better buffer on the stronger yen.

4) & 5) Serious political journalists trying to put their 5-pence worth into the fray ... fergedaboudit already!

6) Strategists at 12 of the biggest Wall Street firms predicted in December that S&P 500 stocks would rally an average 7.8% this year. The unanimous bullish outlook on Wall Street last happened in 2001, when the S&P 500 dropped 13 percent. Too much of a good thing means no one is looking at risk side. Now we are trying to price in risk.

7) The “soft landing” scenario for the U.S. economy was jolted on February 16th with news that housing starts plunged 14.3% in January to a 1.41 million annual rate, the lowest level since 1997. The Fed’s 2-year rate hike campaign has toppled the U.S. home building industry into a severe recession, and now a meltdown in the sub-prime U.S. home loan market threatens the stock market.
In other signs of severe distress in the all important U.S. housing sector, sales of new U.S. homes plunged 16.6% in January to an annualized rate of 937,000 units, the sharpest monthly decline in 13 years. This hard landing scenario bears watching as a worsening of conditions in the US could pull the rug off a lot of bulls' feet.

8) China will be volatile as 60% of players are retail, but the 9% selldown was pure rumours and baseless. Even without austerity measures, the markets there are doing some self-correcting.

In conclusion, my views:

a) been overly bullish

b) still believe we are in a bull market

c) even though external risks have been mentioned, the gravity of correction has been overdone

d) equity markets in oversold territory now but will take a stabler yen to move it back to normalcy, another few days

e) when we look back a week or two down the road, we would all be amazed at the excessive bearishness now

f) the present low point stands a very high chance of being the lowest point for all equity markets this year