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Profitable ways to ride out the year
Yesterday at 10:31:58 See a quite good article share with all of you (from BT)
Quote:
MUCH water has flowed under the bridge since my last column in Executive Money but not many of the fundamentals have changed.
I was an equities bull last July when the emerging markets meltdown looked to some like the end of the bull market. Around Christmas and again early this year, I turned a cautious equities bull, speaking of higher prices but warning of turbulence along the way - around the issues of the US economic slowdown and the downturn in the housing sector; the American equities market's need for an interest rate cut 'fix'; periodic spikes in volatility and resultant stock sell-offs; jitters surrounding the yen carry trade; and equities looking just plain overbought.
And while all the above concerns played out in rather spectacular fashion in end-February and early March, those same worries will almost certainly resurface later this year to spook the markets.
Indeed, just last week, we had another taste of the sort of wild ride that was always going to characterise the year for investors. Shanghai stocks fell a gut-wrenching 4.5 per cent on Thursday but surged back 3.9 per cent on Friday. And that market has since done what it did in late February/early March - that is, bounce back past the prior high.
Which brings me to another set of unchanged fundamentals: the resilience of this liquidity-driven bull market. Nothing has changed there either. Yes, we may see stocks gyrate pretty wildly this year but the lazy money that is burning a hole in the pockets of investors is likely to take prices back up again - and to even higher levels by year's end.
Perhaps the biggest single driver of that equities bull market has been excess global liquidity. G-7 money supply has been growing much faster than the GDP since 2000 (Figure 1). Indeed, this is a trend going back to the early 1980s. But global liquidity growth relative to economic growth flattened out in the 1990s, only to continue again by 2000. And there is no sign of easing in that growing excess liquidity.
Further, it doesn't stop with G-7 countries either. Rapidly growing China is also flush with liquidity. If you consider the Chinese equities market's performance against the country's money supply, the recent vertical stockmarket ascent looks more like a lagged reaction to steadily surging money supply, rather than appearing 'irrational exuberance'. In other words, the vertical ascent was, in a manner of speaking, the stock market's slingshot reaction to the tension of surging liquidity (Figure 2).
There is reportedly 33 trillion yuan (S$6.47 trillion) sitting in bank deposits in China. To get a sense of the size of this wall of money, it is about 150 per cent of the entire Chinese economy. In Singapore, money supply is growing by more than 20 per cent year-on-year. Some sceptics might reckon this is a liquidity 'bubble'. This would be true if it was accompanied by rising consumer inflation and interest rates, and surging stock valuations. But generally, inflation has been muted in most economies and there is generally a lack of upward pressure on interest rates.
Indeed, the asset price inflation of recent years - from equities to real estate - appears almost as the flipside of this general lack of consumer inflation. That is, low consumer prices, driven in part by the globalisation of the supply chain - with production moving to the most cost-efficient parts of the world - have helped keep interest rates low. This in turn has meant a lower discount rate for valuations and a hunger for higher returns from alternatives to cash.
And in any event, what we have seen over the past four years has largely been an earnings recovery-driven bull market rather than valuation multiples expansion. Indeed, valuations remain at the low end of their 10-year range for the US and Europe. And while emerging market PE valuations vary considerably, the average is also still at the lower end of its 10-year historical range.
But I continue to caution that we will have some pretty wild swings this year - not because I doubt the strength of the fundamentals underlying this bull market, but simply because markets do not move up in straight lines. And after four years, the market is vulnerable to mid-cycle corrections.
I sense there is still some unfinished business from the correction of late February/early March. That is, the correction was too mild for what would have been a typical bull market correction over recent years. So there is a possibility of another leg down.
Last May's correction saw 8 per cent knocked off the S&P 500 while this year's downturn saw the loss of 6 per cent. Okay, that was near enough. But emerging markets lost 25 per cent in May last year and this year they lost only some 10-12 per cent. It wasn't much of a correction for emerging markets.
But I stress it is very difficult to call the timing for that correction. So staying sidelined, waiting for that correction, may not be the best idea either. What we can say with more conviction is that given the fundamentals outlined above, corrections are likely to be relatively shallow and followed by strong recoveries as we appear to still be at mid-cycle rather than end game in our current bull market.
The problem with investors staying sidelined while waiting for better buying opportunities is that prices can leave you behind. Indeed, in the 34 years from 1970, the three best buying opportunities on the US market saw equities surge by 21-23 per cent in just one quarter. This means that missing just three quarters out of 136 would have resulted in a huge reduction in cumulative returns.
Inhibiting psychology
And the story of the wannabe bottom-fisher has always been along the lines of: 1. 'Oh, that 3 per cent in a week was too much, too fast. It will come back down.' 2. 'Hmm, it's now up 6 per cent, I can't buy now.' 3. 'Huh? It's up 20 per cent? I give up. This is one that got away. There will be another opportunity.'
But the reality for many market timers is that all too often, the same psychology inhibits serious wealth building all through the journey.
And if you don't think you can tolerate the volatility of an outright long position on equities given the near-term volatility possibility, you can consider structured products that give you partial participation on the upside while protecting against some of the downside. There are also products that pay you relatively high yields on the basis of relative outperformance rather than outright market upside.
And there are also funds that offer long-short strategies to hedge against short-term equities downside or even funds that offer low correlation, multi-asset exposures, focusing on absolute returns.
