Tuesday, May 25, 2010

Euro-led slow down, tensions in Korea, can it get any worse?

The STI lost 2.7% today, falling to 2651.19, at the lowest level since early November 2009. Current investor worries (in decreasing order of importance) are:
  1. A Euro-led global slowdown, leading to a double-dip global recession
  2. Issues related to the Euro area: a potential debt default by one of the PIIGs, a break-up of the Euro-zone, uncertainty over European bank balance sheets, systemic meltdown of the global financial system (ie. Lehman's 2008 failure)
  3. War breaking out on the Korean peninsula
  4. Chinese asset bubble/tightening worries
  5. A (largely benign) financial reform bill being passed in the US, and perhaps, the potential impact of Basel III on financial institutions
While stock markets have corrected severely from their April highs, most (if not all) major stock markets have recently broke through their 200-day moving averages, a rather bearish indication from a long-term technical perspective. We would rather not commit more new funds at this juncture, as the technicals are suggesting further downside but post-correction valuations look rather appealing for many stocks we are watching. 

We can hardly think of any potential positive news which may provide the investment community with a shot in the arm at this juncture (especially to alleviate problems 1 & 2), so any impending rebound will largely be the results of technicals (and the technicals hardly look favourable now!). Given that we are currently short on "powder", we want to keep some dry in anticipation of a major capitulation in the stock market. Investor sentiment is largely negative now which means that we may be approaching the point of capitulation, but we probably need to watch for some of the following to occur:
  • Sell-side analysts need to turn very bearish (consensus estimates for most markets are still on the rise)
  • GDP estimates need to be revised downwards (like market earnings estimates, still on the rise)
  • A "haircut" taken by holders of PIIGs debt, possibly beginning with Greek debt
As austerity measures face significant protests, it is increasingly likely that the country's creditors will have to take a hit. When this happens (we think the market is not yet pricing this in, given the euphoria over the ECB/IMF bailout package), the market could suffer an even larger decline. As has been the case in various financial crises, the failure or near-failure of major financial institutions often mark the market bottom. In the current issues with Europe, the marking down of Greek, Portuguese or Irish debt by European financial institutions could mark the climax of a market capitulation, in which we would be very happy buyers of quality companies which are also sold down in the fray of madness (despite their seemingly lack of association with the troubles of the European economy). 

We continue to like and own Wells Fargo, and are well aware that any negative sentiment on the financial sector will undoubtedly hurt the stock. Nonetheless, the company's strong fundamentals, low (and stable) cost of funding, and prudent management render the company an attractive investment, separating it from its peers. 


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