Beware of distorted markets

In Economy, Financial competency on 28/02/2012 at 2:30 pm

Investors now live in a sort of fairground hall of distorting monetary mirrors. Their perception and motions are twisted by negative real policy interest rates, by topsy-turvy government bond markets, by fiscal deficits which range from large to enormous and by a financial system still considered so fragile that it needs extensive official support. Until the mirrors are straightened – a process that will take years – it would be dangerous to feel too happy about rallying markets.

Another great insight an the Economist blogger

a big enough rise in oil prices that translates into a big enough decline in expected growth and inflation may nudge the Fed from the rates-will-be-low-because-we-want-catch-up-growth interpretation toward the rates-will-be-low-because-the-economy-will-be-weak interpretation.

  1. Market rallies shouldn’t be seen as anything to be happy about at all. It is merely a short term burst of optimism, not uncommon with the irrational stock market, that in the short term always values everything incorrectly. Only in the long term (years) would the market correctly valuate because the trajectory follows the real performance of companies. Of course, this is specific to shares.

    Other securities are far more difficult to predict and mostly depend on prior knowledge of certain trends taking place. The effects of important events such as a war in an oil-exporting country and how it creates an upward pressure on oil futures is a given. But obtaining prior knowledge of it, and particularly prior knowledge of a rather accurate time-table (to correctly make the purchase of oil & related futures) is difficult. In such cases, having insider knowledge helps. But it is therefore something out of the league of most investors.

    I myself am keeping with purchasing businesses (well shares of) in my own country given that the economy is still doing well and is expected to continue to do well for the next 5 years, barring any unusual disaster. Of course, careful evaluation of the individual companies and its market is necessary, seeing as how the export market, like every other export market around the globe, is facing a slump. But yeah, buy shares as if you are buying a company (well, you are), that way, you’d think like a business owner.

    I like your blog, check out mine too.

  2. The most worrying issue of extreme low interest rates should be in the property markets (and REITs by extension).

    In Asian region, countries like China, HK, Oz and Singapore have experienced strong and sustained property price growth over the past 4 years because of low cost of borrowing. Will there be a sharp reversal if rates start to rise or growth flattens? We are talking property assets bought with up to 5 times leverage here. A 10% fall in price can result in up to 50% loss of capital…

    • I have a draft article in the works regarding Singapore’s dangerously low benchmark rates. MAS (Singapore’s Central Bank) has kept the benchmark rates at close to 0% since late 2008. I don’t believe it is necessary to wait for rates to rise in order for the property market to tank. After all, the Singapore government has already put themselves in a tough spot by dropping rates close to zero so they are unlikely to raise it. The market will tank regardless because the prices are just beyond the capability of most prospective home owners to purchase. Eventually (I’m putting it within the next 5 years), there will be a market correction to a more acceptable level.

      This is similar to the 2008 sub-prime mortgage crisis (which is essentially a property bubble burst) or if you far enough, to the Japanese asset bubble crash of 1991.

      I have plenty of friends over in Singapore and I know that calculating by real income trend over the last 10 years (which has largely declined for those below the 20th percentile and stagnated for the rest up to the 80th percentile, with only the top 20% seeing an increase in real purchasing power), at least half of my friends will have to wait till at least 30 before they can even come up with the down payment for a mortgage (assuming that they enter the workforce after 24). And the mortgage term will go to around 40 years at current property price levels (and cost of living).

      This is also exacerbated by a fast-growing population (due to immigration), which increases demand and contributes to an upward pressure on property prices. The open immigration policy is also putting a downward pressure on real income for those below the 80th percentile (which is where most of the immigrants are, given that they come from developing nations). What this meant for people on the ground is that home ownership will either become something that’s no longer universal, or we will see a price adjustment due to market correction. It will, of course, also be a painful episode for the country’s economy.

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