The Prophecy Business

The card dealer at a casino doesn't claim that he knows something about the order in which the cards will come up. He just makes sure that the bets are properly paid and the house isn't being ripped off.

However, it is hard to find a market participant from the almighty CEOs to the lowliest of clerks who is willing to be just a card dealer. For one thing, customers have an unfortunate tendency of asking about what markets will do in the future. The self-glorificating mentality prevalent in the market will forbid any participant to give the simple answer of "I don't know". For then, one will surely be laughed upon, sniggered and despised. That in itself, is bad for business.

Some people have made the prophecy business their very livelihood and there is no denying that in general, their accuracy were as good as that of a simple toss of a coin. Either it goes up or goes down (very rarely does a stock stays at a single fixed price for long). These professional coin tossers are neither mean nor devious. They do not come to office everyday and think what cock-and-bull story shall I invent today. These people are genuinely much more innocent, they only tell others only after they have genuinely influenced themselves about what they think of the future. The worst that can be said of these people is that they wanted so badly to convince themselves that they generally succeed in fooling themselves.

Then again, there will always be an upward bias for all these recommendations especially from investment houses. The general rule of thumb is to not say anything about anybody unless you have something nice to say. Unless one has the kind of incontrovertible evidence to the contrary, any public expression in the negative form will only attract unwanted lawsuits or ill feelings.

Every now and then comes "the era of wonderful nonsense", a delusional theme that is comparable to the fervent belief that the Earth was flat. Few years ago, the theme was that every IT company was a future money-printing machine even if it was burning through tons of cash at that time. Today, the theme was that real-estate prices for the US as a whole never came down ever since the Great Depression, implying that real estate prices are going nowhere but up. I do not profess to know what the next wonderful nonsense will be, but I do know that there will be a next wonderful nonsense in time to come. More likely than not, it is going to be so wonderful that I may fall for it myself.

Clues from the Past: Philip Fisher

Prior to 1932 there would have been serious question from the responsible leadership as to there was any moral justification or even political wisdom in deliberately running a huge deficit in order to buttress ailing segments of business. Now conventional wisdom has changed. If business should really turn down, they would not hesitate to lower taxes or make whatever other deficit-producing moves necessary to restore prosperity and eliminate unemployment.

Deficits of this type would produce further inflation in much the same way that the deficits resulting fom wartime expenditures produced the major price spirals of the postwar period. This means that when a depression does occur it is apt to be shorter than some of the great depressions of the past. It is almost bound to be followed by enough further inflation to produce the type of general price rise that in the past has helped certain industries and hurt others.

It seems to me that if this whole inflation mechanism is studied carefully it becomes clear that major inflationary spurts arise out of wholesale expansions of credit, which in turn results from large government deficits greatly enlarging the monetary base of the credit system. The huge deficit incurred in winning World War II laid such a base.

It is almost certain that a depression will produce further major inflation; the extreme difficulty of determining when in such a disturbing period bonds should be sold makes me believe that securities of this type are, in our complex economy primarily suited for institutions who have dollar obligations to offset against them or to individuals with short-term objectives. They do not provide for sufficient gain to the long-term investor to offset this probability of further depreciation in purchasing power.

The Reappointment

Ben Bernanke's term expires on 31st January and President Obama is going to have to decide whether to replace him with somebody else. If one were to look at past reappointment history such events are more influenced by political rather than economic reasons. It was about whether the Fed Chairman is willing to do the president's bidding and coordinate monetary policies to aid him in the next elections. Though the Federal Reserve is supposed to be a political independent party, nobody really believed that.

Such was the reason why Paul Volcker, a former Fed Chairman whom I highly respect was made to give way to Mr. Greenspan. With the benefit of hindsight, Greenspan was severely over-rated, his era of prosperity was built on a bubble. He was more of a master politician and bubble blower than an economist or regulator. As the way things work in Washington, there is no point in doing the right things if the people are not going to get re-elected for it. Nothing can be worse than doing the right things, laying the foundations for the future, only to see your arch-nemesis getting elected and reaping the benefits of it. George Bush Senior can attest to it and that is also why you can witness the dramatic change in the way how his son handled politics.

Mr Bernanke's dovish approach to the markets is one that would be welcomed by market participants. The "Greenspan Put" analogy is now being replaced with "Helicopter Ben". An assurance that Ben will fly over in his helicopter to release huge amounts of cash and liquidity should the financial system ever get into trouble. Given his dovish approach, experience and now fame for acting early to help relieve the effects of this financial crisis he is highly likely to be re-elected again. Now it depends on whether Obama and his advisers trust him well enough to do the things that they need him to do. If all things were to happen according to the path of least resistance, then we might risk awakening the timeless evil of inflation in the future. Of course, to Obama and company, that is something for the next president to worry about.

House of Cards

A book that I am reading at the moment that depicts a detailed description of how the fifth largest investment bank on Wall Street went under. Truly gripping stuff, feels like having a front-seat experience of how the entire financial system could have collapsed. The author did really portrayed the emotions and thoughts of the insiders. A good read especially for outsiders who want to know how Wall Street operates. From the rumours on the net, to the credit default spreads, to the calls by the OCC, how people with inside information were shorting the stock using options and customers pulling out to materialize into what was a full scale bank run. It highlights the dangers of overnight repo, it can happen very suddenly. It detailed how even the best efforts by the Fed and treasury could not keep a franchise that was more than a century old from collapsing. It detailed how the downgrades by Moody's and S&P could deliver such a devastating blow. The alpha-male culture that is prevalent in Wall Street, never admitting to any weakness or whatsoever.


The baiting and stringing by JPMorgan's Jamie Dimon who successfully acquired the company on the cheap and risk free. Then the ultimate humiliation of Bear Stearns of having to sell itself for $2 a share. I'm still midway of reliving the experience and remembering it in my mind so as to make sure that I recognize these signs when the next one occurs. It happened to Drexel Burnham Lambert and Kidder Peabody in the past, now it happened to Bear Stearns, Lehman Brothers and Merrill Lynch. I am sure it will happen again, another time in the future when the pain has been long forgotten. History never truly repeats itself in the same identical manner, but there are some things about human behavior that can never change.

Thoughts on Technical Analysis

"It will fluctuate." -John Pierpont Morgan

Yes, this is the memorable quote from the legendary banker himself when asked what the stock market will do. Filled with lingos such as head and shoulders, resistance points and support levels. Buy a stock because it has gone up and sell it because it has gone down. This is the exact opposite of sound business sense everywhere else and it is highly unlikely to lead to success in the financial markets.

In my own experience and observation, looking all over the world, never have I known a single person who has become consistently and lastingly rich by "momentum trading". The downside of capitalism is that when people want to hear snakeoil such as a shortcut to lasting wealth, they will get it.

Beware of those, who tell you that one can make money effortlessly by following some sort of arcane technique that some guru has constructed. Though there were legendary speculators like Jesse Livermore that lived through numerous moments of ultimate riches and bankruptcies, it would be interesting to note how he ended his life. Apparently, he shot himself in the head. Whether or not he was playing a game of russian roulette in his own bathtub would be an interesting thought to hold.

I do not hesitate to declare my belief that technical analysis is fallacious as it is popular. Professor Mandelbrot in his book "The (mis)behavior of markets", has successfully replicated the stockmarket movements using unbiased random number generators that are indistinguishable from real market data. A same technical analysis person would look at such datas and start drawing lines, moving averages and MACDs which holds no true meaning or whatsoever. These witchdoctors of finance
have an ulterior motive when they promote such techniques.

The answer comes from the exhorbitant learning fees and voluminous trading which generates huge revenues for the brokerage firms. Little wonder that these techniques are hugely supported by such firms. If their techniques were to be so easy and effortless, why aren't these guys sitting at home replicating money. Why do they even bother to teach in the first place?

This brings me to the next point as well, a technique that actually works in the market once made popular ceases to work. Get enough people to learn about your money-making scheme, the market then starts to be become efficient in it. Which explains why markets are becoming pretty efficient in traditional valuation methodologies. To beat the market consistently, one will have to a higher order level of skill that is extremely unpopular. It is of high likelihood such techniques are ones which goes against the basic human psychological tendencies. Therefore, they are the very reasons why it will work.

Being Emotionally Firm

"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." -Benjamin Graham

A golden piece of advice, easy to say, very hard to do. When people all around you thinks that you are wrong, any normal person would start wondering if he is really the one with the delusion. Staying emotionally firm can sometimes feel like you are driving on the wrong side of the road. When does one really decide whether his principles are right or wrong irregardless of the crowd? The answer is not as simplisitic as it seems to be. Unfortunately the answer can only be obtained by keeping an open mind and learning through experience.

I still hold firm to my belief that markets are currently overvalued, this does not mean it cannot go higher, neither does it mean it should start going lower either. Historically speaking, overvaluation or undervaluations can go on for decades at times. To be someone who to hold strong beliefs against the crowd for that long a period of time must be someone who is truly extraordinary. It seems that there is certain element of truth that most investment carries an element of speculation. There are times when faced with a formidable opponent, even a chess grand master would have to take his chances.

Often we hear stories about people placing a huge bet which ended up to be a life changing event by which they go on to be hugely successful stories. What we don't hear often though, are the stories of those who made the bet but lost.

We humans are genetically programmed to be seek out the success stories and disregard the warnings of the failures. Unconsciously, we avoid and despise the "losers" as we do not want to be associated with them. Any idiot can take the plunge and make huge amounts of money just because of luck. That same idiot will be wiped out when his luck turns. Blessed is the one stupid enough to fancy his chances and realizes his mistake whilst he is on a winning streak.

Even extremely shrewd businessmen and investors like Oei Hong Leong can fall into such traps. When he was winning, people call him the man with golden touch. Now, I bet many are sniggering behind his back, silently celebrating his fall from grace. My opinion is that he maybe down but certainly not out, I do not think we have seen the last of him just yet.

Speculation with high leverage is just like playing a game of russian roulette maybe one with a hundred barrels. I tell you that this gun is loaded with five live bullets which are totally random. For each time you pull the trigger, you will be rewarded a million dollars. How many times would you like to play this game?

Fear drives human behaviour more than greed

Singapore's real estate market has been pretty resilient thus far. Just when the financial crisis is barely over, investors are running head over heels for apartments once again. This time the prices have broken through previous highs and there are even signs of speculation as well.

I would say that the outlook for Singapore's real estate still remains bright for the long term future. However, very much like the equity markets, I think prices have gone ahead of itself. I was pondering about what could have been the key driving factor. What was it that really pushed people through the line to place hundreds of thousands and sometimes even millions betting on real estate? After some thoughts, I find that the answer is more psychological than rational.

I am inclined to believe that it is fear. The fear that when prices skyrocket, people are afraid that they can no longer afford to buy such houses in the future. They are afraid that they would be left behind as they missed the great bullish bandwagon.

As for greed, sure there are people who are in it to make a quick buck. However, emotionally speaking, what human beings really can't stand is the sight of their peers faring better than them. We despise and look down on people around us, thinking that we are all high and mighty. The sight of someone inferior making more money than we are pushes us to take uncharacteristic actions. I see this all the time and I find it to be a far more convincing reason than greed alone.

The world is way more chaotic than one can imagine. I wouldn't dare say that people who jump in right now aren't making an astute decision. When governments of the world are undertaking the path of least resistance, implementing massive fiscal and monetary stimulus. They try their very best to inflate away the troubles with paper money. Though we might not see the effects right now due to rampant deflationary pressures, we might witness later on the future when true recovery comes.

However, I have experienced my own fare share of setbacks to declare anything about the future. I have seen my own opinions gone wrong on more occasions than I can count.

Market Sentiments

"I can calculate the motions of heavenly bodies, but not the madness of people."
-Isaac Newton

Today, the ST Index slid by a significant 85.53 points. Looking at the headlines, it seems that Bloomberg and CNBC have been pretty oblivious as to the real cause of concern for investors. These are perhaps signs of media manipulation by the US government. Every bad news has been twisted and deformed to sound like a green shoot to drive up market sentiment. If you noticed, they all come with a positive tinge. Every good news is given headline space. Investors might have realized that they have been taken for a ride by the conventional media for quite some time.

The selloff orginated from China. Perhaps, investors have realized that the massive monetary and fiscal stimulus by the Chinese government is temporary at best. Increasing real private consumption is going to take some time. Behavioural change of Chinese consumers is not going to happen overnight and it takes more than just credit expansion to drive sustainable growth. This would require a developing of a proper social safety net, whereby people need not worry about old age. Robust bank lending standards are needed to prevent speculators from needlessly driving up asset prices. The old economic model of being the world's manufacturing factory is not going to work if nobody is buying the goods. In other words, China will have to reinvent itself and start acting like a world economic superpower.

Then again, though its future is immensely bright, this is something that is not going to happen over a short period of time. It is a multi-year process and still very much a work in progress. I must admit that I am not willing to stick my head out to declare that this is a start of a correction or a double-dip as anticipated by many other forecasters. For all you know that markets might rocket even higher soon, but is the market way too far ahead of itself?

The intellectually honest answer is that I do not know. The long-term forecasted earnings of the S&P 500 is going to be 50-60 and the question will be what multiple does it deserve. The unbiased long-term average of the S&P500 history is around 16X which leads to a fair value of 800-960 points. So the market seems to be pretty pricey at this point in time. Coupled with the fact that there are several underlying problems that have yet to be solved, I do not believe the recovery is going to be v-shaped.

What are the problems that I have in mind:
- Collapse in corporate earnings
- Commercial Real Estate
- Credit Cards
- Financial institutions that refuse to delever
- UK house prices
- Option ARMs

I believe that all these problems are going to have an impact one way or another at least in the short run. If there is going to be any recovery it is going to be subdued. The US governmental policy seems to be blowing one bubble to another, always kicking the problems down the road to the next administration. Never wanting to do the right thing and purge the corruption as well as rotten practices out of the system.

At this moment, they are now trying to blow another bubble by allowing financial insitutions to have a free rein. They have changed the accounting standards to let zombie insitutions continue roaming on this earth, lending money at extremely cheap rates. Many of these insitutions are still living in a world of more than 20X leverage. When these institutions get the money, they gamble and toss the coin once again. Heads I win and keep the money, tail the government bails me out again. Therefore, there can be little doubt about who are driving up these asset prices.

Then we have a problem to ponder about, when is it going to end? When is the fed going to stop giving these institutions unlimited amounts of cheap money? The plan was to provide these insitutions with liquidity while they slowly claw back their equity and delever without causing financial chaos. However, instead they are now taking the money to drive up asset prices.

Is this experiment going to work? Will animal spirits and the rise in asset prices generate the positive wealth effect that is sorely needed? Will they succeed in blowing another bubble? I seriously doubt so. The largest asset of the American consumer is real estate not equity or any other asset classes. If you don't turn housing around, you have not solved the single largest underlying problem. As long as it is not resolved, the American consumer cannot spend again.

Then again, these are only opinions, I have yet to attain the kind of expertise or experience to know for sure what will happen.

Thoughts on National Day Rally 2009

My thoughts of what goes on in the minds of the typical Singaporean

- Economy: Alamak no bonus, tax rebates or ang pows ah?

- Healthcare: Everyday work so hard for so long where got time to exercise?

- Race and religion: Yah lor, Singaporeans become more active in religious groups, now must pray harder then can dio 4D or Toto.

From the looks of it, we are not going to have an election anytime soon.

The New Paradigm for Financial Markets

"Living in London was a comedown. I had no money and no friends. After my adventurous life, I was full of myself, but the people in London was not interested. I was an outsider looking in, and I discovered lonliness. There was a moment when I ran out of money. I was having a snack at a Lyons Corner House, and after paying for my food I had no money left. "I have touched bottom," I told myself, "and I am bound to rise, This will be a valuable experience."
-George Soros

I was reading this book for the second time ever since I bought it. But what really caught my eye this time wasn't the Theory of Reflexitivity or the predictions that Mr. Soros made that turned out to be right or wrong. Rather, what caught my attention was the fact that I could sense his determination in the face of extreme adversity. The intense emotions that were described by a mere few words that made the read all worth while.

Though readers with mindset of a higher order should dwell into the abstractions of Reflexitivity, the idea is pretty simple but difficult to prove. However, this economic rally can potentially verify his ideas. The equity market rebound began in March way before other economic inidicators turned positive. Later several indicators did in fact turned positive whilst others continued to languish. An empirical observer would say that economic signals are more mixed rather than unidirectional. The euphoria driven by "animal spirits" could be said to be, a product of successful propaganda and media control. Perception is not reality, but perception drives reality.

If this rally were to be sustainable and rise in the various asset classes were to successfully generate a cumulative wealth effect. Then it would give us a better insights into how financial markets operate. Fundamentals drive sentiment or is it sentiment that drives fundamentals?

Students of financial literature, myself included, are educated and trained to place much more weight on underlying fundamentals. However, before the crisis came upon us, I could still remember several analysts declaring that the sub-prime crisis would be contained and have minimal impact if any at all. They pointed out to figures of earnings which justifiably show that the fundamentals of several companies continue to hold strong. Record earnings, record sales and strong financial positions, the fundamentals could never been better. What a difference a year has made!

Now fundamentals are down substantially and the future from my point of view remains rather bleak. There could be 2 explanations to such a phenomenon:

1) Our perception of what constitutes to be "strong fundamentals" are flawed and investors forgot to ask themselves "How much?";
2) Fundamentals are really driven by sentiments or "animal spirits" which should really be an essential part of economic theory.

Though I was inclined to believe the former, but with each passing day I find myself swayed towards the latter. However, all is not set in stone yet for the definitive answer could only be determined by the future.

The Centris

Investing in Real Estate is tough business, as Mum and Dad can attest to it. Though the potential rewards are great, so are the pitfalls that you can get into. Numerous days of travelling across the country. Looking for suitable lights, furnishings and furniture. Making sure that the defects are corrected. Looking out for good tenants and trust-worthy agents. Most importantly, you need to do your due dilligence and have lots of good old luck. Fortunately, experience here would pave the way for others as well. Anyway this one is situated above Jurong Point 2, right beside Boon Lay MRT. And yes, it's near NTU.

Does prices eventually catch up with value?

"That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realized it in one way or another." - Benjamin Graham

Lately, I have been disillusioned by the notion that markets will eventually revert back to the true value of any common stock. People who have done valuations before would understand, that to do a proper valuation of any stock is not easy as it seems. For equity valuation is indeed a truly complex business.

Intellectually speaking, the true value of common stocks of course should not be found by reference to the price movements but rather by the discounted cashflows of the future without the depending on the vagaries of the markets. However, there are several problems with this conventional valuation technique. The most apparent ones would be the measurement of risk and forecasting.

In terms of risk, current financial literature seems to be moving in the wrong direction. Be it the single-factor CAPM or Fama and French's three-factor model, what most of models attempt to do is simply to explain price fluctuations. What matters the most instead should be the downside risks of the company's future cashflows. My view is that most academics are missing the whole point here. However, I can understand where they are coming from. Few investors have the emotional capacity or ever saw themselves holding a stock for more than five years much less even ten, twenty or thirty years. Moreover, when you sell your stock, your terminal cashflow will still ultimately depend on the market price itself at that time.

Secondly, there is a problem of developing good forecasting techniques. In many instances, variations in historical key ratios are too large to create anything that offers good predictive value. The result leads to the creation of an unbelievably large range of prices for any stock, which would be useless in most instances. Most of the time, these ranges would be useless perhaps save for a few rare extreme occasions.

Coupled with ethical and incentive problems prevalent throughout the entire financial industry. It would be extremely rare for anyone to come across insightful, independent and objective valuations. Even if there are, it would be difficult to filter it out from the rest of the noise. Thus, logically speaking there is no way the market as a whole can actually figure out where true value of companies lie. If this were to be the case, then there should be no time limit by which the mispricing of securities can last.

Target Asia Fund Performance Report

As the economy improves, the Asian stock market continued its rally. China’s rapid loan growth, strong property and stock market performance have raised concern that its economy may be over-heating. We believe that such concern is premature. The Chinese government has been monitoring the situation closely and has signaled that it will soon slow down the loan growth. Loan quality is also being checked constantly.

As the world economy recovers, Asia should again outperform. We monitor stock valuation closely and continue to top slice those outperformed stocks where valuation has become too rich too quickly.

Option ARM: The second wave of this crisis or just fear-mongering?

I once saw this graph before in early 2007 when Bear Stearns got into the first signs of trouble. Despite the recent massive rally in asset prices ever since the lows of March, the thought that a comparable second wave might come is just too much to stomach. That is why I have yet to buy into this rally. Perhaps the situation has changed and this graph is no longer valid. Maybe through loan modifications the impact might not be as great as imagined. It is also possible that the market might have already taken this into account. However, this graph has proven its mettle once and I'm not about to bet against it a second time.

RGE: Singapore Economic Outlook

• Exports will decline sharply due to global electronics downturn but industrial production has bottomed out.

• Consumer spending and investment will contract. Asset market rally might be temporary due to weak domestic fundamentals and global volatility.

• Fiscal and monetary policies will be accommodative until 2010 due to sluggish recovery in exports and domestic demand.

A high dependence on exports and financial services has pushed Singapore’s economy into a severe recession that is much worse than the 1997‐98 or 2001 downturn. The yearover‐year contraction in GDP growth that began in Q4 2008 will extend through all four quarters of 2009. But the pace of contraction in GDP growth and exports might ease in H2 2009.RGE Monitor expects GDP to contract 5.5% in 2009 after growing 1.1% in 2008. A small consumption base and strong export linkages of investment and industrial production imply these indicators will see a deep U‐shaped recovery. GDP growth will remain sluggish in 2010 at an estimated 1.4%, depending on the pace of recovery in U.S. and China, the savings rate in the U.S. and EU, and improvement in global credit conditions and financial activities. However, accommodative fiscal and monetary policies are a positive amid large job losses and risks of workers' aversion to the political system. Large foreign exchange reserves, strong external positions and credit ratings will cushion Singapore from any revival in global risk aversion.

Export Recession Far From Over

The pace of export contraction has eased since March 2009 but volatility on a month‐to‐month basis implies that export improvement is largely being driven by inventory restocking in export destinations. Improvement in exports is mainly driven by pharmaceuticals while electronics and petrochemicals continue to contract at a sharp pace. Given that demand in the U.S. and EU are unlikely to show a marked improvement at least until late 2009, exports will continue to contract through 2009. Since a large share of exports to other Asian economies (Hong Kong, Malaysia and China) is re‐exported to the U.S. and EU, exports to Asia will also contract. Any recovery in 2010 will largely depend on the revival of global demand and electronics cycle, both of which are expected to be sluggish.

Imports have been contracting sharply since most of the imports are for re‐exports. But trade and current account surpluses have been easing due to Singapore's import dependence. If commodity prices pick up temporarily, external surpluses could come under further pressure. But this will be largely contained as commodity prices will be lower than their 2008 levels and consumer spending will contract.

Investment Takes a Beating

Due to a low domestic consumption base, industrial activity and investment are strongly driven by exports. There has been some improvement in industrial production in late Q2 2009, but mostly due to strengths in sectors such as pharmaceuticals and biomedical. Other sectors such as electronics and chemicals will continue to contract sharply through 2009 due to the global electronics downturn. These exports will also witness a very weak recovery in 2010. The Purchasing Manager's Index (PMI) moved into expansion territory in Q2 2009. But given that a sustained recovery in domestic and export demand is still distant, any improvement in PMI and manufacturing output going forward will be slow. The pace of manufacturing recovery in 2010 will depend on the strength of export growth.

The service sector will continue to contract, led by financial services and a slowdown in retail, tourism and real estate as consumer are aggressively cutting down spending. Consumer spending and exports are expected to recover at a sluggish pace in 2010. Inventories are still high, taking into account demand forecasts for 2009 and 2010. So firms need to aggressively cut down inventories in the coming months. Firms also face tight credit access in capital markets while corporate earnings in 2009 will remain dismal. Therefore, investment is expected to fall sharply in 2009 with a sluggish recovery in 2010 depending on the pace of improvement in global trade and credit conditions.

Labor Market Downturn Hits Consumption

The export manufacturing sector and financial services will continue to shed jobs sharply through 2009 amid demand slack and tight credit conditions. Government stimulus measures have somewhat helped contain lay‐offs but any improvement in hiring prospects will be driven by improvement in global conditions in 2010. Layoffs are expected to continue through most of 2009 so that the total jobs lost in this cycle will exceed the jobs lost during the 1997‐98 or 2001 downturn. The unemployment rate is expected to rise from 2.25% in 2008 to close to 5% by 2010. As most of the immigrants who are laid‐off leave the country, Singapore’s already low consumption base is shrinking. Due to this, the sharp contraction in retail sales and consumer spending is expected to continue through 2009, notwithstanding government tax stimulus measures. This will be exacerbated by negative wealth effects from 2008's correction in equity and real estate markets and tight bank lending standards. Given high import dependence, any taxbenefits spent by households might be leaked via imports.

Asset Market Correction Continues

Singapore's equities have rallied since March 2009, buoyed by capital inflows and surging liquidity. Valuations are some of the most attractive in Asia, especially in sectors most affected by the recession such as exports and real estate. However, another market correction cannot be ruled out given the possibility of revival of global risk aversion and domestic risks. The bleak corporate earnings witnessed in Q1 2009 will continue through 2009 making the export and real estate sectors vulnerable again. A sluggish recovery in exports and domestic consumption will raise investor concerns about the health of the corporate sector.

Low interest rates in the U.S. and EU until 2010 will keep Singapore's short‐end yields low at least until 2010. This will be supported by capital inflows, improving liquidity, deflationary pressures and the central bank’s bias for an undervalued currency. Financing the fiscal deficit and fiscal stimulus package with past fiscal surpluses and foreign exchange reserves implies that fiscal pressures during 2009 and 2010 will not put any upward pressure on yields.

The Singapore dollar (SGD) has been trading above the mid‐point of the exchange rate band set by the central bank in the April 2009 monetary policy meeting. This has been led by capital inflows and U.S. dollar weakness recently. However, there are risks to the SGD in H2 2009, including revival of risk aversion and investor concerns about the weak economy and corporate earnings. Further devaluation of SGD by the central bank is unlikely in 2009. But the central bank will nevertheless intervene to keep the SGD in the lower end of the exchange rate band to support growth. The SGD might get a boost in 2010 as the central bank begins to tighten the monetary policy. Strong external surpluses and foreign exchange reserves will cushion the SGD in the event of any risk aversion.

The housing sector has witnessed sharp price correction but starting Q2 2009 there has been some improvement in home sales and prices. However, this has been led by rise in home resales, in lower end sections and in sections where prices are now attractive. The entry of buyers has been mostly due to improving sentiment, speculation, rise in capital inflows, liquidity surge and the stock market rally. But all these trends might be unsustainable in H2 2009 and even in 2010 given weak fundamentals for home demand.

Job losses will continue through 2009 with weak hiring in 2010 leading several immigrants to leave the country. Households continue to face wage pressures and wealth erosion. As a result, demand will fail to keep up with the supply of homes leading to further price correction. Commercial real estate may face further downturn in H2 2009 due to bleak corporate earnings, falling business spending and plunging retail sales. Rising vacancy amid oncoming supply of commercial real estate space will cause rentals to follow sharp downward trend.

Bank credit growth has slowed sharply during the current downturn. But there has been some improvement in loan growth in Q2 2009 led by consumer loans and loans to small and medium enterprises under the government guaranteed loan scheme. However, credit to the corporate sector remains under pressure. Declining investment implies that corporate lending will remain subdued. But there are some positives for banks. Interest margins are rising and local banks have the scope to take over lending activity left by retreating foreign banks. Strong capital‐adequacy ratios are helping banks to withstand some deterioration in asset quality from rising nonperforming loans from households, corporates and the real estate sector.

Room for Fiscal Measures

The $13.7 billion fiscal stimulus package was implemented in early 2009, financed in part by drawing from over $3 billion of the country's foreign exchange reserves. The stimulus package includes credit incentives for firms to retain workers, ease taxes and credit access for firms, credit transfers for the poor and unemployed and spending on public services. These measures have somewhat contained lay‐offs and improved credit access for small and medium enterprises. Despite being aggressive, the stimulus will be insufficient to boost growth in 2009 and 2010 as firms face slack demand and households have low propensity to consume. Despite the expected sluggish economic recovery in 2010, there might not be another stimulus package.

High spending and tax cuts in the stimulus package and slowing tax revenues from individuals, corporates and financial activities will push the fiscal balance from a surplus of 1.8% of GDP in 2008 to a deficit of over 4% of GDP in 2009 and 2010. But fiscal discipline, large foreign exchange reserves and external surpluses during boom years will give enough room to maintain loose fiscal policy.

Monetary Policy Takes Cues from Exports and Inflation

Singapore has been in technical deflation since April 2009. Deflationary pressures might continue until early 2010 amid contracting domestic demand, large excess capacity and labor market slack. Inflation in 2010 is expected to remain subdued and will be driven by the pace of recovery in domestic demand. While commodity prices will be lower than the 2008 levels, some strengthening in commodity prices might raise the risk of import inflation.

In April 2009, the central bank moved the exchange rate band to a lower level without changing the width or slope of the band, leading to a devaluation of the SGD. The SGD has actually been trading in the lower end of the exchange rate band since late 2008 due to the central bank's intervention in the foreign exchange market to support exports.

If the sharp contraction in GDP growth and exports witnessed in H1 2009 extends into H2 2009, which seems unlikely, the central bank may further ease the monetary policy by devaluing the SGD. However, this might be limited by the risk of import inflation, especially if commodity prices strengthen. Moreover, the central bank's devaluation bias will make investors averse to Singapore bonds. The central bank's move will also be limited if any revival of risk aversion going forward causes the SGD to depreciate. The central bank has in the past emphasized the limited impact of exchange rate depreciation in boosting exports in the short‐term. But in any case, monetary easing bias will be maintained until sometime in 2010 due to sluggish recovery in exports, economic growth and inflation.

The Way Forward for Economic Policy

Singapore’s ruling party, the People's Action Party (PAP) faces pressure to maintain its popularity amidst the severe recession. As a result, in May 2009 the government proposed reforming the parliamentary system by allowing non‐PAP members to control up to 20% of parliamentary seats in the next elections. Doing so could be seen to give non‐PAP members more say and to promote a debate on the political system and economic policies. In early 2009, the government also implemented a fiscal stimulus package giving transfers to households and unemployed workers and tax and credit incentives to companies. Given that the economy will recover at a sluggish pace in 2010, the government will face pressure to maintain loose fiscal policy and contain public aversion to the political system.

However, the government will limit the extent of voting powers to the non‐PAP members who sit in the opposition. So the government will continue to have a strong hold on the political system, whether in reforming the political or legal structure or voting on economic policies, irrespective of its dwindling popularity among voters in the recent years. The government also recently passed a law to restrict public demonstrations indicating that restrictions on civil liberties will continue.

The government also plans to hold elections before the constitutional deadline of 2010. However, elections in the immediate term might be ruled out as fighting the recession occupies most of the government's time. Moreover, there are risks of calling for an election as voters face rising job losses and reduced spending and aversion to the present political structure grows.

But the biggest challenge for the government will be carving out an economic model for Singapore. This is imperative as de‐leveraging in the U.S. and EU reduce demand for Singapore's exports and competition from Hong Kong and Shanghai and greater financial regulation pose risk to Singapore's edge as an Asian financial center. The government will also have to address high income inequality and Singapore's shrinking population as immigrants leave the country during the recession.