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.