Is the worst really over?

Business Times - 12 May 2008

STOCKS
Is the worst really over?

By R SIVANITHY
SENIOR CORRESPONDENT

IS THE worst of the financial crisis over? Depends on who you ask and what the definition of 'the worst' is - if it's the credit crunch that's being referred to, then the answer is probably yes. But if it's the consequent impact on earnings and the economy, then the answer is probably no.

A couple of weeks ago, the answer the market would have given was a resounding yes to all questions - Wall Street was shooting up, the US Labor Department released a surprisingly robust April employment report (more on this later), and stocks in this part of the world were being lifted along with the euphoria.

There was no such thing as bad news, all news were good news, and Wall Street investment banks too were speaking of the light at the end of the tunnel, though as with incumbent politicians and government-appointed officials, this was perhaps only to be expected.

Friday's drop in the US, however, came after bigger-than-expected losses at American International Group and news that the firm needs to raise US$12.5 billion in capital. According to wire reports, it would appear that this has thrown a spanner in the works and has led to a rethink as to whether more shocks and large capital-raising exercises lie ahead.

A word about the April's US employment report is perhaps warranted. Barron's columnist Alan Abelson described it in the May 5 issue as a brilliant narrative worthy of winning the Pulitzer Prize for Fiction: the increase in employment came from the birth/death adjustment, which was a figure created to capture additional jobs of firms too new to be captured by the survey, he pointed out.

According to Mr Abelson, an astonishing 8,000 jobs were added in the financial sector via this adjustment, a mystifying figure given that the sector is currently laying people off. Equally incomprehensible was the 45,000 jobs created in construction, a sector that is hardly booming and is indeed suffering one of its sharpest downturns ever.

So, is the worst really over? Maybe. Our sense is that the probability of a major upheaval has diminished for the time being, though it remains to be seen what other new bubbles the US Federal Reserve's actions have inflated and what might happen if these burst.

If we were to attempt to attach probabilities to various scenarios, it might read something like this: probability of the market suffering a major blowout within the next month - 10-15 per cent; probability that the US market has underestimated the extent of its economic slowdown - 50-60 per cent; and probability of stocks posting a positive return from now till year-end - 40-50 per cent.

Obstacles include oil at above US$125 a barrel and the likelihood of the US Fed not cutting its interest rates for the rest of the year.

BCA Research in its latest Global Strategy report said it believes that the equities rally is not over yet and recommended that investors stay the course. 'The rally in global stock prices may have advanced to a point where some corrective action could take place. Nevertheless, the broad picture remains unchanged: The US economy is weak but is probably moving onto a recovery path. The developing world remains strong and the growth profile in that part of the world is unlikely to change very much either.'

'The biggest risk to the global stock market rally is oil,' BCA maintained. 'The escalating crude market is creating increasing stress for the world economy. Nevertheless, we are probably not at the 'choking point' yet, especially if borrowing costs could fall further.'

The early part of the week ahead will see local blue chips come under some pressure because of Wall Street's Friday plunge, but as always, much thereafter depends on expectations of what Wall Street might do in the days ahead. Also a given is that Hong Kong will set the pace as it has always done, as investors grapple with the question of whether the worst is really over.

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