Financial Freedom SG

I just read a research report from CIMB just this evening before writing this blog. In it, the report used technical analysis to predict that there will be a sharper correction due in the next few months till end of October in financial markets.

In this post, I shall try to look at the arguments for both sides. Is it going to be bear or bull?

A bear market is coming.
1. The first evidence for this is that there are some markets where there is a evident bubble building. The China stock market is trading at higher than 50 PE ratio, which basically means that prices are at 50 times multiplied by earnings. So all else being equal, based on current earnings, you will get back your money after 50 years. That is pretty sobbering. This means you have to live to 50 years and the company either have to increase their earnings or there has to be more people chasing after the stock for it to go higher for you to sell. Who is going to hold the can when it falls?

Even if the China market is the hottest in the world right now, the smart move will be to move your money out from the market by at least about half right now. The more sane PE ratio will be around 25 times. So halving your money from a market with PE ratio of 50+ is a good move. This Time magazine article, although a bit dated, provides a good picture of what is happening to the hot China market. When even taxi drivers and people with no idea wants to have a piece of the action, it is time to take extra note and be careful.

2. The second piece of evidence for a bear market coming is that there are signs of a credit crunch in markets from US to Europe where banks and financial insitutions are ensnared in the subprime loans defaults. This has a ripple effect in the financial markets as these companies would have loans to other businesses which may have to return these loans for the financially strapped financial institutions to survive.

That is in a nutshell why the central banks in Europe and United States are pumping liquidity into the markets. Their fear is that it is already late because the banks and other financial institutions are likely to become suddenly very conservative and scrutinise their loan books more closely. This Economist article sums up this effort to shore up this credit crunch well.

3. One word- Aginflation. I've read about this word just this week, so I don't think I am qualified to talk about it. Basically it is agriculture inflation where the twin pressures of the growing global population and the increase use of biofuels to replace fossil based petrol is making prices of agriculture products going up through the roof. You can read this article at Reuters news to get some information on this.

The bull market is still strong.

1. The basis for saying that the bull market is still strong is based on looking at the simple PE ratio. In this SeekingAlpha article, it shows that the global PE ratios are mostly around the 10+ figure with only China and Japan having high PE ratios of more than 37. This article, although published in Jun is based on the Nov 2006 figures. So the ratios would have gone up somewhat. In fact it shows that the PE ratios have not hit their historical highs yet. So based on PE ratios globally, there is still an upside to most markets.

2. The economic indicators are still bullish. If you take a look at The Economist industrial output and latest GDP figures, the economy is still humming nicely along. If there is a slowdown in these figures, coupled with a credit crunch in the financial markets because of the subprime meltdown, then there will be a full blown recession. However, at the moment, the industrial figures look to be still healthy.

A concern, looking at these figures, is the increasing consumer prices which makes the central bankers' job very hard. On one hand they want inflation to decrease, so they want to increase lending rates. On the other hand, they need to put a booster into the financial markets to restore confidence, so they need to decrease interest rates. It will be interesting to see how the Federal Reserve Chair acts in the next meeting. My feel is that I agree with the CIMB report, a sharper correction is just around the corner.