Saturday, February 24, 2007

The Sun Always Shines (only on TV)

On Tuesday, MOS had alerted investors that we should exercise "especial caution" in the market. With the festive boozing getting to our cranium, we had inevitably failed to explain our case. That, as a result, drew several mails from irate readers who suggested that MOS is attempting to talk the market down.

Hence, we would like to take the opportunity to present our case today. We consider this to be a period of unprecedented bullishness across many asset classes. From memory, the current PER of the local market is about 19x, only a shade off the high of 22x registered in the technology bubble. This same sentiment is observed in international markets, may it be the US or emerging countries. The recent returns of the Dow, S&P 500, TSX are very strong. Emerging market equities such as Vietnam, China, India and Latin American countries are also trading at extremely extended levels too.

We also understand that junk bonds and highly leveraged debt instruments are abound in the market today and they continue to proliferate. In addition, REITs, which are a hybrid between equities and debt, are yielding less than their ten year government bond benchmarks.

For some reason unknown to us, fear has virtually vanished from the market. The VIX, aka the Fear Index of US, is languishing near record lows, ranging around 9 - 10 when highs of 20 - 30 were registered only as recently as 2002. Even the volatilities of major currencies, an asset class synonymous with volatility, are below normalized (ten year) levels.

These record setting highs are engineered by the substantial liquidity that has been sloshing around for over a year. The combination of petro-dollars and the wealth of the rising Chinese are plausible causes for this liquidity glut. But it will take only a quick and rude shock to the global financial system to bring about the withdrawal of the hot money.

The strains are starting to show. In January, the sub-prime mortgage market in the US tanked. The industry benchmark, the ABX, nosedived after several lenders reported higher loan losses, delinquencies and defaults. MOS does not think that issues in the housing market will be contained within the sector. The housing slowdown is likely to have knock-on effects on the broader US economy. And should the world's largest economy go into a tail spin, the other nations are unlikely to fare any better.

It is always difficult to play the party pooper. And it’s never going to be easy to convince Noah to build the ark when rain is not in evident in the horizon. But, the sun always shines, unfortunately, only on TV.

Credits: The title is a play on A-ha's smash hit from the 1985 album, "Hunting High and Low" - "The Sun Always Shines on TV".



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