Are You Petrified? A Report on the Recent Correction.

As most of you should have read from the front pages of every major newspapers in Singapore, there seems to be a financial Armageddon around the corner. Is it time for a double dip recession? In my opinion, the correction is overdone and the fears is too irrational regardless of the fundamental and macro environment. The current market environment is not really like 2008. For starters, Americans aren't drowning in debt, banks aren't lending beyond their means, and investors aren't overexposed to the stock market. 

In fact, stocks are trading almost at low as 12 times earnings estimates which is cheap by any standards

Let see what are the reason attributed to the fall:

-          US Consumer spending and manufacturing slowing down

-          Euro crisis will spread to Italy

-          US credit rating was cut by S&P for the first time since WWI

Slowing US Economy

This is a real concern. However, there are very mix information with the market choosing to disregard the good news. US employment rates improved better than expected on last Friday and Consumer spending, which is the main driver of the economy, is expected to do well with the reporting this evening. There are good news and there are bad news and the market seems to weigh on the bad news much more than the good.

Credit Crisis in Europe

There are fears that the crisis in Europe will continue to spread. And this time, spread to the biggest nations such as Italy. This is a valid concern but nothing new. This problem has been around since last year when Greece first defaulted. This time round, the EU is much more proactive and aggressive in dealing with the crisis which is seriously lacking in the last bailout. I believed that the market has already factored a big chunk of that risk and shouldn’t have effected a 15% one week fall.

Credit Cut of US by S&P

Personally, I believed that certain insiders have obtained the news that S&P is about to cut US credit ratings and the selling started one week before the announcement. Let’s face it. Regardless on the rules on insider trading, most of the best profits made by traders and investors are from insider information. I believe that this may be the real reason for the 15% fall in the market. The main reason why the ratings cut will affect the economy as explained in my last article, will lead to higher interest rates as investors will demand a higher interest for a now higher risk US treasury. The increased interest rates will lead to a slowdown in the US economy and potentially tip it back into the recession. However, in this case, the US treasury yield went down on Monday instead of going up as what economic theory dictates it to happen. (A fall in treasury means an appreciation in the value of the bond.) The US treasury is a unique case in which it is the world reserve currency and the haven from economic risk. The uncertainty from the credit ratings lead to falling risk appetite around the world to sell risky equities to buy the now higher risked treasury bills. Isn’t that an irony. In short, as long as the credit ratings does not cause a real impact in the economy, than the rating cuts will probably be a minor factor affecting any future economic growth. Here is an article by investment Guru Warren Buffet on a Saturday interview:

By Liz Claman

Published August 05, 2011

| FOXBusiness

Berkshire Hathaway   Chairman and CEO Warren Buffett    told the FOX Business Network that S&P's downgrade of the United States' triple-A credit rating     "doesn't make sense."

"I don't get it," Buffett told FBN late Friday night. In fact, Buffett reaffirmed his belief in the quality of the United States' credit telling FBN, "In Omaha, the U.S. is still triple A. In fact, if there were a quadruple-A rating, I'd give the U.S. that."

Buffett told me tonight that Berkshire Hathaway's T-bill exposure is significant.

"We just filed our 10Q and we have $47 billion in cash and cash equivalents. Well over $40 billion of it is in short end T-bills. (Tonight's S&P downgrade) doesn't tempt me to sell. We'll stay right there."

Buffett sounded no alarm bells about the downgrade, going so far as to say it wouldn't have much effect on the markets     Monday. "If nothing else takes place, meaning, if all other variables hold and there isn't say, a new problem in Europe, it won't make any difference."

"Think about it. The U.S., to my knowledge owes no money in currency other than the U.S. dollar, which it can print at will. Now if you're talking about inflation, that's a different question."

When asked if he felt the U.S. deserved the downgrade, Buffett said, "No." He took a swipe at S&P, quipping, "Remember, this is the same group that downgraded Berkshire."

The downgrade has prompted some economists and market watchers to warn that interest rates may rise, the dollar      may weaken and stocks could see a sell-off. When asked whether he was worried about market gyrations Monday, Buffett said, "No."

Judging from all the factors, the most probably cause for the major correction is the credit cut as the news is splashed across all major newspaper creating tremendous fear. The cautious reporting doesn’t help to assure retail investors. If I am a professional investor, I will probably have heard from a grapevine about potential cuts, sold and started to scope all the cheap stocks after the news break and mass hysteric occurs.

Our Strategy

Judging from today’s market action, my hypothesis is proven to be correct. The STI corrected to as much as 5% before it recovered to -2.89% as of 4pm today. Previous market action before the credit announcement is a straight line down, which goes to show when the big money is intervening. Well, the joke now is that recovery is now probably been push back another year or two, which in a way is good as it will buy us time to accumulate wealth before the next major recession hit. This is not the best time to exit the market because, my guess is we are probably at the market low. My allocation also made sure that we can participate in the recovery process and at the same time withstand any market shocks. My main allocation is in Gold, resource, SEA and Asia ex Japan in general. If you see from the chart below from the last one week performance, SEA countries did the best while European and US markets did badly. Indonesia, as usual is outperforming even when the markets around us are crashing. If you have any queries, do send me an email.