By Goh Eng Yeow
HAVING too much of an apparently good thing can be bad for your financial health.
The recent epic rout in the silver market may have been of no more than passing interest to the average investor here.
However, it offers a stark lesson on how the hunt for a safe asset with a higher potential return can result in unnecessary risks which undermine investments.
Investors have been left licking their wounds as the price of silver crashed by a spectacular 30 per cent in the past fortnight, after surging close to its historic highs last seen 40 years ago.
Still, some sympathy is in order for these investors over the exuberance which led to their folly. The world is awash with cash as the United States central bank prints more than US$2 trillion (S$2.5 trillion) in fresh money to try to stave off an American recession.
With the US Fed's printing press in over-drive, investors have been justifiably worried about the erosion of the value of paper money and this has led them to search for safe haven assets which can offer them a potentially higher return.
So it is hardly surprising that precious metals such as gold, platinum and others are in great demand among investors.
As the search for safety gathered pace, investors also extended their bets to other metals such as silver and copper.
But while the ordinary investor buys precious metals in a small way to try to hedge his risks against escalating prices, big-time traders such as hedge fund managers carry out the same exercise on a far bigger scale.
For them, there is an added advantage: The US Federal Reserve has slashed interest rates to almost zero in its efforts to help businesses there get back on their feet.
But its action also enables hedge fund managers to borrow huge sums at almost zero costs to make huge bets on any asset which can offer them a potentially higher return.
This means that markets in commodities such as silver can quickly become over-heated, as all sorts of participants fall over one another to get a slice of the action by bidding prices higher.
This leads to the build-up of what is known as a 'bubble', where prices reach unrealistic levels due to the huge surge of liquidity into the market.
In such cases, the bubble usually bursts when the liquidity is removed. For the silver market, that came with the decision of the Chicago Mercantile Exchange - the world's largest commodities exchange - to clamp down on the cheap loans made available for betting on the silver futures market.
It did this by raising the margin, or the amount of cash down payment, which a trader has to put up in order to finance his purchase of a silver futures contract. This action caused silver prices to tumble, as weaker players were forced to cut their positions after failing to raise the additional cash.
One consolation is that the rout in the silver market failed to produce a financial storm on the scale of the one experienced in 2008, which nearly caused the global banking system to collapse.
It is an instructive lesson on how a search for safety ended up encouraging risky investment behaviour.
But if you believe that the silver market is an isolated instance of irrational exuberance, you may be mistaken.
Take China's red-hot residential property market, for example, where Shanghai's new home average prices surged 15.3 per cent in a week, according to a Chinese property consultant, Shanghai UWin Real Estate Information Services.
What is disconcerting is that the rise in prices is not the result of a housing shortage but rather an attempt by mainlanders to buy multiple homes - which they then leave mostly vacant - as part of their efforts to guard against inflation.
What happens to those empty houses if there is a sudden shrinkage of liquidity in China's economy, leaving their owners unable to service their mortgages?
The parallels with the calamity which has overtaken the silver market may be too compelling to ignore.
Showing posts with label Bubble. Show all posts
Showing posts with label Bubble. Show all posts
Thursday, May 19, 2011
Wednesday, March 30, 2011
Bursting the recovery bubble
Published March 30, 2011
Don't count on a complete recovery anytime soon, says chief investment strategist at S&P's Equity Research, reports PAUL J LIM
(NEW YORK) DESPITE recent volatility in global markets, domestic stocks have doubled in value in the past two years, the fastest such gain since the Great Depression. And financial shares have fared even better, soaring more than 160 per cent since the long stock rally began in March 2009. But will the broad market in general and financial stocks in particular resume this torrid pace? Perhaps not.
Unsustainable: It's hard to imagine how much longer the broad market can keep up the pace of the last two years, some market strategists say
Consider how stocks have fared over a much longer stretch - since the end of the previous bull market, in March 2000. Last Thursday was the 11th anniversary of the bursting of the technology bubble, a reminder of how long it may take investments at the centre of a major market plunge to return to their past glory.
For example, though most sectors of the Standard & Poor's 500-stock index are now trading above their levels of March 2000, the overall index is still slightly below where it was then. And technology and telecommunications stocks - the market's best performers leading up to the 2000-02 bear market - are still down around 60 per cent, on average, from their peaks 11 years ago; blue-chip growth stocks are off about 35 per cent.
What's the moral of this story? Don't count on a complete recovery anytime soon, said Sam Stovall, chief investment strategist at S&P's Equity Research. 'It could take 15 years for stocks to work off the effects of a major bubble,' he said.
Mr Stovall has studied market recovery periods in the years after World War II. He has found that while it usually takes stocks about 14 months to return to previous highs after a mild bear market, and five years, on average, to bounce back from a severe downturn of 40 per cent or more, it typically takes even longer to recover from a bubble.
He noted, for example, that after oil prices peaked during the energy bubble in 1980, it took 16 years for some categories of oil-related stocks to recover to their pre-bubble highs. And after gold peaked in 1980 at around US$850 an ounce, it took 28 years for the price to return to its pre-bust perch. (Of course, even at US$1,426 an ounce, gold still hasn't recovered to its 1980 levels when adjusted for inflation.)
The reason recoveries take so long 'is that a true bubble occurs only when valuations are taken to extremes, and it usually requires at least two bear markets to bring those valuations back to historic norms,' said James B Stack, editor of the InvesTech Market Analyst newsletter.
To be sure, one could argue that the valuations of financial shares have never skyrocketed the way those of tech shares did in the late 1990s. In fact, at the end of 2007, when the global credit bubble had popped, the price-to- earnings ratio for financial stocks stood at around 17, according to Bloomberg. That's about on par with valuations for the broad market at the time.
Yet that happened because the reported profits of financial companies had soared leading up to the plunge, Mr Stack said, so that earnings - the 'E' in the P/E ratio - generally kept pace with rising prices. 'But in reality,' he said, 'many of those earnings were built on artificial sources of income that were not only going to dry up but reversed course when the asset bubble popped.'
Another reason to believe that financials may soon hit a ceiling, Mr Stack said, is that 'there are still too many people waiting to get out' of those shares. In other words, many investors are still holding onto financial stocks not out of faith, but because those shares are still so far below their October 2007 peaks - about 50 per cent, on average - that they've have been waiting for a bigger rally before selling.
Haven't financials surged over the last two years? Yes. But Jack A Ablin, chief investment officer at Harris Private Bank, notes that since the first three months of this rally - when financial stocks bounced back the most - these shares have actually lagged behind the broad market. Since the start of June 2009, the S&P 500 has gained 42 per cent, versus just 34 per cent for the financial stocks in the index.
Mr Ablin said 'conditions during this stretch couldn't have been any better for the banks', alluding to the government's efforts to keep short-term interest rates near zero, assuring substantial profits when banks relend that money to customers. 'Yet this is all we got to show for it,' he said. 'That would suggest that it could take many years for the fundamentals of this sector to recover.' As for the broad market, it's hard to imagine how much longer it can keep up the pace of the last two years, some market strategists say.
Beyond the threat of rising inflation, as well as various geopolitical risks, valuations are becoming stretched. David R Kotok, chief investment officer at Cumberland Advisors, says a simple way to judge the frothiness of the market is to consider the ratio of total domestic stock market capitalisation to gross domestic product (GDP).
'History says that when stock market capitalisation is about 55 per cent or 60 per cent of GDP, stocks are a great bargain, which was the case during the March 2009 lows,' Mr Kotok said. 'But when stocks are 110 per cent of GDP, it's time to sell.' Today, the stock market is worth about 95 per cent of GDP. 'So,' he said, 'I don't believe the market has a large strategic move upward from here in the short term.' - NYT
Don't count on a complete recovery anytime soon, says chief investment strategist at S&P's Equity Research, reports PAUL J LIM
(NEW YORK) DESPITE recent volatility in global markets, domestic stocks have doubled in value in the past two years, the fastest such gain since the Great Depression. And financial shares have fared even better, soaring more than 160 per cent since the long stock rally began in March 2009. But will the broad market in general and financial stocks in particular resume this torrid pace? Perhaps not.
Unsustainable: It's hard to imagine how much longer the broad market can keep up the pace of the last two years, some market strategists say
Consider how stocks have fared over a much longer stretch - since the end of the previous bull market, in March 2000. Last Thursday was the 11th anniversary of the bursting of the technology bubble, a reminder of how long it may take investments at the centre of a major market plunge to return to their past glory.
For example, though most sectors of the Standard & Poor's 500-stock index are now trading above their levels of March 2000, the overall index is still slightly below where it was then. And technology and telecommunications stocks - the market's best performers leading up to the 2000-02 bear market - are still down around 60 per cent, on average, from their peaks 11 years ago; blue-chip growth stocks are off about 35 per cent.
What's the moral of this story? Don't count on a complete recovery anytime soon, said Sam Stovall, chief investment strategist at S&P's Equity Research. 'It could take 15 years for stocks to work off the effects of a major bubble,' he said.
Mr Stovall has studied market recovery periods in the years after World War II. He has found that while it usually takes stocks about 14 months to return to previous highs after a mild bear market, and five years, on average, to bounce back from a severe downturn of 40 per cent or more, it typically takes even longer to recover from a bubble.
He noted, for example, that after oil prices peaked during the energy bubble in 1980, it took 16 years for some categories of oil-related stocks to recover to their pre-bubble highs. And after gold peaked in 1980 at around US$850 an ounce, it took 28 years for the price to return to its pre-bust perch. (Of course, even at US$1,426 an ounce, gold still hasn't recovered to its 1980 levels when adjusted for inflation.)
The reason recoveries take so long 'is that a true bubble occurs only when valuations are taken to extremes, and it usually requires at least two bear markets to bring those valuations back to historic norms,' said James B Stack, editor of the InvesTech Market Analyst newsletter.
To be sure, one could argue that the valuations of financial shares have never skyrocketed the way those of tech shares did in the late 1990s. In fact, at the end of 2007, when the global credit bubble had popped, the price-to- earnings ratio for financial stocks stood at around 17, according to Bloomberg. That's about on par with valuations for the broad market at the time.
Yet that happened because the reported profits of financial companies had soared leading up to the plunge, Mr Stack said, so that earnings - the 'E' in the P/E ratio - generally kept pace with rising prices. 'But in reality,' he said, 'many of those earnings were built on artificial sources of income that were not only going to dry up but reversed course when the asset bubble popped.'
Another reason to believe that financials may soon hit a ceiling, Mr Stack said, is that 'there are still too many people waiting to get out' of those shares. In other words, many investors are still holding onto financial stocks not out of faith, but because those shares are still so far below their October 2007 peaks - about 50 per cent, on average - that they've have been waiting for a bigger rally before selling.
Haven't financials surged over the last two years? Yes. But Jack A Ablin, chief investment officer at Harris Private Bank, notes that since the first three months of this rally - when financial stocks bounced back the most - these shares have actually lagged behind the broad market. Since the start of June 2009, the S&P 500 has gained 42 per cent, versus just 34 per cent for the financial stocks in the index.
Mr Ablin said 'conditions during this stretch couldn't have been any better for the banks', alluding to the government's efforts to keep short-term interest rates near zero, assuring substantial profits when banks relend that money to customers. 'Yet this is all we got to show for it,' he said. 'That would suggest that it could take many years for the fundamentals of this sector to recover.' As for the broad market, it's hard to imagine how much longer it can keep up the pace of the last two years, some market strategists say.
Beyond the threat of rising inflation, as well as various geopolitical risks, valuations are becoming stretched. David R Kotok, chief investment officer at Cumberland Advisors, says a simple way to judge the frothiness of the market is to consider the ratio of total domestic stock market capitalisation to gross domestic product (GDP).
'History says that when stock market capitalisation is about 55 per cent or 60 per cent of GDP, stocks are a great bargain, which was the case during the March 2009 lows,' Mr Kotok said. 'But when stocks are 110 per cent of GDP, it's time to sell.' Today, the stock market is worth about 95 per cent of GDP. 'So,' he said, 'I don't believe the market has a large strategic move upward from here in the short term.' - NYT
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