Plan for Recovery
From the Investment Desk
Eddy Tan
Head, Analytics & Asset Allocation

Bush & co. didn’t find any weapons of mass destruction ("WMD") in Iraq. Instead, they exported their own version of US-made sub-prime and credit WMD that blew up everywhere in the world. Equity markets were severely hammered last week.

US equity indices lost >20% the whole of last week. Central banks around the world appear to have coordinated desperate moves to deal with desperate times, from injecting liquidity, to resuscitating financial institutions, to guaranteeing deposits (to prevent bank runs), to slashing interest rates (100bp in Australia, 50bp in many other countries).

Consider Iceland "bankrupt" – the volcanic country of 320,000 people should have kept more gold bullion. Exporters to Iceland are asking for upfront payment, many avoiding Icelandic krona. Tempers are flaring elsewhere – in Pakistan, between Thailand and Cambodia over a temple,…

No wonder, gold is still holding up above US$800. Last Monday, US equity indices staged a powerful +11% rally, a 75-year historic jump; while ST Index rose 6.6%. US equity indices fizzled since then, and so did other markets. Equity indices could test the last low.

- Hedge funds reported redemption orders placed last month, which should pressure equities come December. I reckon outflow of US$1.6-2 trillion, from multiple of 4-5x of US$400 billion redemption. Fortunately, our recommended hedge funds could still employ short and use liquid instruments.

- Focus has shifted away from sub-prime. There are more defaults in prime mortgages. Wait for the other shoes to drop – credit cards, automotive loans and commercial property loans, as recession bites and credit remains tight. JP Morgan, Citigroup and American Express, among others, issuer credit cards. Recent equity injection by US government could ease some pressure, for now.

- UK residential house index is under tremendous stress, given the higher leverage and that prices have not fallen as rapidly compared to the US. We reckon up to 25-30% downside in UK home value.

- The size of credit derivatives, at US$60 trillion overwhelms global GDP. The size of derivatives of all sorts is even a larger US$600 trillion. Several voices call for regulation of these instruments. We look forward to that, but taming such monster will be a nightmare.

- The war on naked shorts evolves into a war against all kinds of equity shorts. That is blunder – equity markets tumble, nonetheless. Shorts grease the wheels of capital markets. Italian Prime Minister’s call to halt global equity trading is also another mistake; fortunately he retracted.

- Volatility Index ("VIX", tradable on CBOE), which measures investors’ fear, soared to >70. Some pundits target 90. Goldman Sachs volatility traders made a killing. Under normal circumstances, VIX hovers around 24.
- Spikes in LIBOR rates (>4% for USD, >5% for ₤) still express suspicion among banks (cash hoarding). Businesses are getting squeezed from tight credit, so expect pressure on corporate earnings. Let’s apply discounts to those projected PE multiples. Initial attempts to unfreeze credit will take time, which will invite confidence back to businesses and equities.

- Global bail out tab nears US$3 trillion. Global printing presses are cheapening currencies. Central banks have restricted (their own) gold lending, sending lease rates higher to >2%.

Plan For Recovery in 2H09 (fingers crossed)
Many of us spend hours glued to the internet and television searching for answers but only to see more bad news. Until next year, expect >10% daily fluctuation. There will be casualties. Bail out programs won’t rescue every financial humpty dumpty. Failed entities lead to job and pay cuts, and haircuts by creditors, counterparties, shareholders and tax payers.

But that should lead to a new era of prudent banking practices. Certain Asian, Middle East & BRIC economies flushed with surpluses will keep their economies humming; their equities have been unfairly sold down.

Plan now and prepare deploying cash to buy depressed but attractive assets. Monthly RSP is the way to go and would position medium to long term investors for the market recovery.


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