Will Central Bank Interventions Just Delay The Inevitable?

Source : The Business Times, August 13, 2007

The US sub-prime mess hasn't yet run its course. Volatility will remain high in the days ahead, and this will offer plenty of trading opportunities for short-sellers and day traders. On the one hand, most research houses, brokers and analysts believe that plunging prices have created a conducive buying environment - and they are recommending clients to buy.

Witness Credit Suisse's well-timed 'overweight' on the local banks last Wednesday, for example, which helped push the sector up sharply.

Similarly, BCA Research in its Aug 10 Global Investment Strategy stated 'market sentiment is still very fragile and emotional while investors have been spooked'.

'It is hard to predict what share prices will do in the days ahead. However, we urge clients to maintain composure. We should always be ready to buy when there is blood on the streets and dead bodies are floating on the surface'.

Add to such urgings the increasing pressure on the US Federal Reserve to cut interest rates, and we have a reasonable case for 'buying the dips'.

On the other hand, you can't help but worry that while the European Central Bank and other major central banks may have bought some time when they made the unprecedented move last week to inject liquidity into the system, they could simply only be delaying the inevitable all-out crash in markets.

Those looking to buy might wish to note the recent comments of Nobel-prize winning economist Joseph Stiglitz, who spoke of the roots of the sub-prime crisis lying in the economic and monetary policies of Alan Greenspan and George Bush after the Nasdaq crash of 2000. The full effects, he said, have not been felt yet.

In a nutshell, his thesis is that Mr Bush's tax cuts aimed at enriching the wealthy and Greenspan's interest rate cuts at about the same time had the combined effect of inflating a huge housing bubble. This then enticed lower-income Americans to try and play the property game, leading to the sub-prime mortgage crisis gripping markets today. Our best guess is that even though the market has known about the problem for a good six months now, the end game is not yet upon us because the full impact has still not shown up in US consumer spendings and corporate earnings.

Short-sellers have stepped up their activities after smelling blood and, in such a climate, it's best to view bounces with scepticism because they would invariably include a hefty short-covering element. As such, it's probably best to be overweight cash, or to stay defensive for the time being.

For those who opt for the latter, this means looking for companies with low valuations, steady earnings, strong balance sheets and a track record of paying good dividends.

Unfortunately for hordes of retail punters, criteria such as these probably exclude most of Sesdaq and a sizeable chunk of penny stocks listed on the mainboard. In the space of 12 trading days, the UOB Sesdaq Index, for which no price-earnings ratio exists because the majority of its components have no earnings, has lost 24 per cent.

Perhaps not surprisingly, among its biggest losers are those that had been earlier pushed to stratospheric heights on pure speculation - Baker Technology, for example, was 55 cents on July 24 but has since collapsed by 47 per cent to 29 cents now, while Alantac was 59.5 cents four weeks ago but has since crashed an astounding 71 per cent to 17.5 cents now.

Many in the market feel that the whole penny mania started with video surveillance firm LottVision which in April announced a move into the China lottery market, but in May announced it expects a full-year loss for the year ended March 31.

Its shares had been jacked up to 72 cents in April but sold for 29.5 cents prior to a trading halt last week, a loss of 58 per cent.

Needless to say, few punters here caught at the top of the penny bubble would have expected the end to have come because low income American real estate punters have been unable to meet their mortgage payments.

If anything, the sub-prime crisis has served as a timely wake-up call, a much-needed reality check that valuations do matter.