Hope for the best, prepare for the worst

Published June 29, 2011

By R SIVANITHY

POOR volume, weak prices and no real interest from the investing public - stockmarket players would by now be familiar with these features that have haunted markets for about three months now. Optimists claim this to be a 'soft patch' - the same term used to describe the current downturn in US and global growth. Once the soft patch is overcome, then the second half will see a recovery take grip and markets rallying, they say.

Is this really the case? Or are there good reasons for investors to think that, this time, things may be different?

First, don't let the Straits Times Index's (STI) modest 4 per cent loss for the year fool you, because the index really owes its relatively lofty position to only a handful of stocks like the banks and those in the Jardine group. The FT ST Real Estate index, in the meantime, is down 8 per cent in 2011, the All-share index has lost just over 7 per cent, and the Catalist index is down 14 per cent.

Anecdotal evidence from dealers is that the current funk the local market finds itself in is among the worst they have ever experienced because not only are the external economics bad, so is local confidence - badly shaken by the frequent uncovering of fresh China-related scandals.

Much of the blame for the downturn rests with Western markets - in particular, the US and Europe. Both are plagued by problems stemming from excessive leverage; Wall Street's were exposed first in 2008 and its banks had to be rescued by a sympathetic central bank that now realises it has run out of ammunition to keep the ball rolling, while Europe's debt problems, on the other hand, are only just starting.

In America's case, officialdom's strategy of pushing up the stock market with free money in the hope that it would create a cascading wealth effect on the broad economy has failed, mainly because Wall Street operates as a closed club - which means the free money went straight into the pockets of the small number of investment banks that caused the 2008 crisis in the first place, with precious few other beneficiaries.

Now that that money has run out, things don't look particularly good: unemployment is above 9 per cent; consumer sentiment and spending in an essentially consumer-driven economy are weak; manufacturing (which was never a strong point) is slipping; public and private debt are still at record levels; and the housing market is still sinking. Federal Reserve chairman Ben Bernanke last week expressed surprise at the weakness, saying he did not have precise reasons why the latest economic numbers have been bad. (To be honest, the only real surprise is that he should be surprised.)

Over in Europe, there are reports that Greece's problems are just the tip of a derivative-laden iceberg. The New York Times last week reported that the gross debt of Portugal, Italy, Ireland, Greece and Spain is US$616 billion, but this figure may be magnified if derivative exposure is taken into account. If so, then the repercussions of multiple defaults could be devastating.

There is also a strong argument that the problem faced by Greece and some of the other debt-laden nations is outright insolvency and not illiquidity. And stating 'there's little defence against another slump' last week, finance professor Nouriel Roubini highlighted Europe's 'large and rising public and private deficits and debt, damaged financial systems that need to be cleaned up and recapitalised, massive loss of competitiveness, lack of economic growth and rising unemployment' as further signs that make a double-dip recession a distinct possibility.

So what should investors do? The obvious answer is to 'go defensive' - that is, switch to high-dividend-paying stocks with solid pedigree such as real estate investment trusts (Reits) and bank-linked preference shares. Beyond that, it may be that when the record books are written on 2011 sometime next year or thereafter, they will show that this was indeed a temporary blip in the long road to recovery.

However, given that the authorities appear to have run out of policy options (as well as ideas), it would probably be advisable for investors to hope for the best but prepare for the worst.