Business Times Singapore Investment
Roundtable
Bear market rally or rebound?
William R. Thomson
May 30, 2009
OVERVIEW
THERE is a great divide among
economists on whether the global economy has begun a sustainable
recovery from its worst recession in 70 years or is simply slowing
its rate of contraction. Are the so-called 'green shoots' of
recovery firmly rooted, or just frail seedlings destined to wither
again in an economic climate of prolonged stagnation and deflation?
For investors, this translates into a question of whether stock
prices are poised to enter a new bull market or are simply in
a classic bear market rally. BT gets the views of four pundits.
Panelists
Eisuke Sakakibara, Professor at Waseda University and
formerly Japan's Vice-Finance Minister for International Affairs
Mark Mobius, Executive Chairman, Templeton Asset
Management
Jesper Koll, President and CEO, Tantallon Research
William Thompson, Chairman, Private Capital Ltd, and
senior adviser to Axiom Funds
Moderator: Anthony Rowley,
BT's Tokyo correspondent
Anthony Rowley: Prof Sakakibara, you took a bearish
line on prospects for global stock markets when you spoke at
an investment seminar in Bali during the Asian Development Bank
annual meeting there a few weeks ago. Do you still feel the same
way?
Eisuke Sakakibara: After two quarters of very sharp economic
decline, it is only natural to have some kind of rebound and
that is what is happening now. Stocks have rallied but this is
what could be called a bear market rally. Look at the Nikkei
- it has gone above 9,000 towards 9,500 but it has now hit the
ceiling and is coming down and it will again break 9,000. People
try to cling to any sort of good numbers and there are some good
numbers here and there after a very sharp decline. But I think
this will be a fairly deep and prolonged recession. This is what
could be called a 'balance sheet recession'. A financial bubble
has accumulated during the course of the past 10 or so years
and it burst in 2007. Asset prices have come down, both in real
estate and in equities. Although there was a rebound in the equity
market, house prices are still coming down and will continue
to come down for another year or so. That has really hurt the
balance sheets of individuals and corporations. It takes time
to adjust balance sheets and this is exactly what we experienced
in Japan in the 1990s. It is now happening to the US.
Anthony: Mark, you fired up the audience at
the same seminar with your bullish views. How are you seeing
things now, and when do you expect a resumption of sustainable
growth in the global economy?
Mark Mobius: I think that growth has already begun
and that it will continue as long as governments around the world
continue to stimulate their economies and to increase the money
supply.
Anthony: On which side of the divide do you
stand, Jesper?
Jesper Koll: The global economy started a cyclical
recovery around March-April 2009. Three factors are at work.
First, the cumulative effects of the unprecedented mobilisation
of public resources is starting to bite and is now sufficient
to counter the negative pull of private demand. Second, the drop
in global energy and commodity prices brings a very welcome boost
to the terms of trade for industrial countries. And finally,
corporate managers are seeing positive results of their very
dramatic cost-cutting and restructuring actions taken since last
fall - inventories are back under control and breakeven points
have been cut. The last point is key because this is why business
confidence is beginning to improve. Last autumn, corporate managers
did not know what hit them, the shock was unprecedented. Now,
they are back in control. Excess debt, excess capacity and excess
jobs have been cut. The question now is whether anybody in the
private sector will step-up to actually raise investment, build
new factories, new call-centres, new supermarkets. Bold entrepreneurs
will be much better off buying distressed assets, distressed
companies on the cheap, rather than building new facilities from
scratch. I expect a boom in mergers and acquisitions, massive
industry consolidation, be it steel, shipbuilding, refrigerators
or flat panel screens. In other words, the private sector will
get 'leaner and meaner', rather than adding new capacity. It
will be a golden age for entrepreneurs, but the overall economy
will suffer because the public sector will have to start the
payback for the massive intervention. Everywhere, from China
to America, taxes will go up, interest rates will go down.
Anthony: And you, Bill?
William Thompson: The omens are not good. Sustainable
economic recovery in the wake of a banking crisis takes longer
than a standard cyclical adjustment. Japan stuttered along for
a dozen years before 'enjoying' five years of sustained, substandard
growth. In a sense, it has never fully recovered to its pre-crisis
conditions. After a dreadful winter, spring has arrived and the
US economy seems to have pulled out of its nosedive; however,
it is a second derivative phenomenon; the rate of decline has
slowed but the direction is still down. With the huge amounts
of bailout money being pumped into the economy through both the
budget and monetary operations, we are closer to stabilising
things. Inventory adjustment is largely complete and restocking
at some level must recommence. De-leveraging, unfortunately,
still has a way to run. In summary, the road ahead will be bumpy.
We may see a positive quarter or two by the end of 2009 or early
2010. But that should not be confused with renewed sustainable
growth. We are all Japanese now!
Anthony: How soon is recovery likely to translate
into improved corporate earnings and thus higher stock prices
- or has the market rally fully discounted improved prospects?
Mark: (The recovery) is already beginning to impact
corporate earnings. It is important to note that not all companies
are seeing decreased earnings. A number have already announced
increased earnings. The market is looking to 2010 and it apparently
likes what it sees. Of course, there will be overshooting and
corrections along the way.
Jesper: Everywhere, the terms of trade for
corporations are improving - wages are being cut, unemployment
is rising, commodity prices drop, supply-chains are being streamlined.
And even the big Japanese conglomerates are finally beginning
to sell off non-core divisions to focus on core-competence. In
my view, corporate profits will explode and analysts estimates
are far too pessimistic. This is true for the US, for Japan,
and especially for the Asia-Pacific. Europe and Latin America
will lag behind because corporate managers there are relatively
more complacent.
William: The recent rally has been quite strong,
as would be expected after the crash of 2008/2009 when the market
was dramatically oversold. In my view, it provides investors
with a great opportunity to adjust their portfolios and perhaps
build liquidity for better opportunities ahead in the coming
months. 'Sell in May and go away' continues to have validity.
It is too soon to know whether we are in a bottoming process
or an interlude before going to new lows. I tend towards the
bottoming process viewpoint because the money being printed has
to find a home and there are values around for the careful stock
picker although the experience of 1929-32 would indicate we could
still go to new lows from here. I would expect earnings to be
higher in 2010 than this year, more because costs are being reduced
so savagely than revenues are rising.
Anthony: How do you view the prospects for new
credit creation by banks and non-banks, since this is presumably
critical to any pick-up in consumer demand in the US and other
advanced economies?
Eisuke: All the major banks have received public
money and that is why they are surviving. They have to continue
to rely on public money for some time to come. Some of the positive
results we are seeing are at least partly the result of change
in accounting rules. Mark to market rules have been relaxed somewhat.
We should be careful in assessing what is now happening.
Jesper: Bank credit growth is accelerating
smartly and the balance sheet constraints are largely an issue
of the past. Whether borrowers are credit worthy is really the
only constraint we have now. Now, bankers are back to being traditional
bankers and, whether you like it or not, a significant part of
US households simply do not qualify for a long-term mortgage
or loan. Clearspeak - until now, it was the banks' balance sheets
that had to get cleaned up. From now, it is the consumer balance
sheet that needs to show real improvement. Only when 'Joe Sixpack'
has paid back debt and brought liabilities back in line with
assets and future income stream, will we see growth in the stock
of mortgage credit and consumer credit. Probably, this balance
sheet clean-up will take at least another 12-18 months. In the
meantime, a big opportunity for banks will be the coming wave
of privatisation - the massive purchases of credit by governments
and central banks will start to be sold back to private investors.
In my view, the valuations of these coming deals will be key
to future financial performance.
Mark: The prospects for new credit creation are very
high in view of the increased money supply and lower interest
rates. Banks will be hard pressed to continue conservative lending
policies.
William: Banks have funds to lend but credit
has contracted in the economy as a whole largely because of the
severe contraction of the shadow banking system. Two years ago,
for instance, hedge funds had US$2.5 trillion under management;
today, that is about US$1 trillion and de-leveraging is still
underway. The result is that banks are now more cautious and
requiring larger downpayments as housing prices remain under
pressure. In addition, a form of financial protectionism is occurring
worldwide. As governments have assumed more influence over their
banking systems, they are forcing banks to keep up lending at
home with the result that they are reducing their overseas activity.
Anthony: Even if banks become more accommodating,
do you think people will be prepared to borrow in order to finance
consumption before they have paid down existing debt and cleaned
up personal balance sheets?
Eisuke: No, they are now adjusting their balance
sheets. They have borrowed too much and they have borrowed against
assets, prices of which have risen quite dramatically during
the past 10 years. Now, asset prices have come down and they
have to repay their debt and that is why the savings ratio is
increasing. This will at least continue for another year or two.
The corporate sector will remain in a defensive mode. I do not
see any dramatic signs of increasing investment on the part of
the corporate sector in the US.
Mark: I doubt that people in the US are willing to
give up their lending patterns and deprive themselves of the
things they see in the department stores and supermarkets. The
US is a consuming society and as long as credit cards are available,
the spending will continue. Of course, there will be some downturn
in view of the banks' more conservative policies.
William: This is very much a balance sheet recession
for the consumer. Their jobs have been lost or are under threat,
many have lost their homes and their retirement savings have
been halved or worse. The glory days of the American (and British)
consumer are well and truly gone. Globally, there has been a
wealth loss of over US$50 trillion or one times world GDP and
in the US, it is more like 1.5 times GDP. There has to be an
extended period of savings build-up before new debts can be taken
on. It is a new paradigm.
Anthony: What about the outlook for bond markets
given the massive accumulation of government debt in the US and
elsewhere and the intense strain on corporate balance sheets.
Is there anything to go for in the bond markets?
Mark: Bond market prospects for emerging market bonds
are good in view of the declining interest rates and declining
interest rate spreads for emerging markets bonds and US Treasuries.
Jesper: Yield curves are steep and particularly
long-term bonds offer good value, in my view. The rally in bonds
will start the moment the government starts raising taxes or
cutting spending. And the Fed beginning to talk about an exit
from quantitative ease will, in my view, also be good for long-term
bonds. Why? Because it is highly likely that the Fed will do
exactly what the BOJ did in Japan - start tightening too early.
Timing-wise, I think this will become a very interesting play
from this autumn.
William: It seems quite possible that the next
bubble that is being created is in government debt. The US went
into this recession with a balance sheet debt of around US$6
trillion. It has just about doubled in the last year if you count
Fannie Mae and Freddie Mac debt, now they are effectively nationalised.
Then, you have a further US$45 trillion off-balance sheet liabilities,
according to the Peterson Institute, of largely untouchable entitlements
such as Social Security, bringing debts to about 350 per cent
GDP, which compares with 250 per cent GDP at the peak in 1929.
The US budget deficit this year and next is estimated by the
Congressional Budget Office to be US$3.1 trillion, or 22 per
cent of GDP. The UK is in much the same situation and, indeed,
there are sensible voices warning the country may once again
be forced into the arms of the IMF. Government bond prices went
to unsustainable levels over the winter and spring and are now
reacting to the expected flood of issues. Since a bout of inflation
is an unspoken, but probably essential, element in working out
of the present situation, I would not buy long-term governments.
Intermediate term maybe and inflation indexed bonds certainly.
For those capable of an analysis of corporate resilience in today's
turbulent times, there are opportunities given their unduly large
spreads over governments.
Anthony: Which areas of the equity market are
likely to see more than a temporary 'relief rally' in advanced
and emerging (Asian especially) markets?
Eisuke: Corporate earnings are down. Look at
the earnings of major Japanese corporations. Most of them are
in deficit. This is the worst experience during the course of
the past two or three decades.
Jesper: Prospects for corporate earnings are
best in Emerging Asia, Japan and the US. Europe and Latin America
are lagging behind. Key here is how aggressive corporate managers
are in restructuring their business, much more so than what government
policy is doing. This recent rally, in my view, is not a bear
market rally, but the beginning of the new reality - markets
will be highly volatile and much more range-bound, rather than
trending upwards. You have to be stock specific, company specific.
While there are many uncertainties, one thing is clear - the
gap between the good companies and the bad ones is going to widen
dramatically in the next couple of years. This is true for Emerging
Asia, China, Japan or the US.
Mark: Most interesting are the consumer and commodity
areas. Per capita incomes continue to rise in Asia and emerging
markets in general, so the prospects for consumer-oriented stocks
is good. With growth continuing in the most populated countries
in the world, China and India, commodity prices will continue
to recover.
William: Let me start with gold. It remains
an essential insurance element in portfolios today as a hedge
against inflation, currency devaluation and general chaos. I
look for higher prices over the next few years. The US dollar's
position as the sole reserve currency is being called into question
as never before and the Chinese are putting their heads above
the parapet for the first time. They quietly doubled their gold
holding between 2003 and 2007 and I believe they have continued
to build them since then. It is the same for the Russians and
must only be a matter of time before other Asians and Middle
East governments do the same. Commodities were dumped in last
year's meltdown and prices have recovered somewhat as inventories,
especially China's, are rebuilt. They have a place in portfolios,
especially agricultural ones where prices remain depressed. Ditto
natural gas. I continue to prefer some Asian emerging markets,
including the Asean ones which are commodity exporters and do
have problems with their banking systems. Taiwan, with its improving
relations with the mainland, is an interesting recovery play.
I do not like Eastern Europe which still has a horrendous adjustment
to undergo. Brazil, with its increasing ties to China, is very
interesting. In developed markets, the US is probably further
through the recession cycle than Europe. There are probably opportunities
there in the areas that Obama's economic policies favour, including
green and renewable energy, medical care and biotech and infrastructure.
Anthony: Prof Sakakibara, or perhaps I should
address you as 'Mr Yen', I can't resist the temptation to ask
you, in closing, for any comments you may have on the outlook
for currency markets.
Eisuke: Currency market will be quite volatile.
For the time being, the yen will appreciate and it is perceived
as a safe haven. Despite the fact that the performance of the
Japanese economy and the Japanese market is not good, I see some
further appreciation towards 95 in the dollar-yen. The dollar
will be strong against the euro. The yen may strengthen somewhat
further, both against the dollar and the euro.
Anthony: Thank you all for sharing your wisdom
with us.
KEY POINTS
- Bold entrepreneurs will be
much better off buying distressed assets, distressed companies
on the cheap, rather than building new facilities from scratch.
- Sustainable economic recovery
in the wake of a banking crisis takes longer than a standard
cyclical adjustment.
- There has to be an extended
period of savings build-up before new debts can be taken on.
- It seems quite possible that
the next bubble that is being created is in government debt.
Government bond prices went to unsustainable levels over the
winter and spring and are now reacting to the expected flood
of issues.
Copyright
© 2009 Singapore Press Holdings Ltd. All rights reserved.
May 29, 2009
William R. Thomson
email: wrthomson@btconnect.com
321gold Ltd
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