Markets are extremely nervous about what lies ahead, with traders questioning the near-term fate of the global financial landscape. Many are asking, how do you invest in a market where there is a clear crisis in confidence?
Volumes are low for a reason, and that is because the investment case for equities is currently poor. There is weak earnings visibility for companies; hence why very few were brave enough to provide guidance during the last reporting season. While the aggregated forward P/E (price to earnings ratio) of the ASX 200 is at a 26% discount to the ten-year average, the S&P is trading 20% less than the day before Lehman's collapsed, which suggests that both markets are dirt cheap. So, does anyone trust the forward earnings assumption, especially if we do see a US recession or contagion spread through Europe? And while valuations are cheaper (in many cases more than the GFC), this does not seem to be enticing participants to buy as the headline risk remains.
Confidence wanes in the US
The S&P (the institutional benchmark) has seen around $75 billion withdrawn from equity mutual funds in the last four months. This works out to be about 3% more than the $72.8 billion that was withdrawn in the four months after the Lehman's collapse. Consumer confidence is at its lowest since April 2009, while investor confidence is no better. And why would it be when there is so much risk in the market, with every macro headline causing massive gyrations in the risk assets?
The European roller-coaster
In the last two weeks, traders have had to deal with rumour and speculation on whether Greece is going to get its next tranche of the first bailout. There has also been concern over whether the 17 European nations would vote in favour of the expanded European Financial Stability Facility (EFSF). Austria was recently in focus, when it was first disclosed that it was not even going to vote on the EFSF. This announcement caused huge price swings in US equities and risk currencies, and then one hour later it was revealed that Austria was actually misquoted and was simply delaying the vote! There has been speculation that China would save the day by using some of its $3.3 trillion of reserve to buy peripheral debt (something it would be mad to do right now), although this would certainly be a positive for its biggest export destination and risk assets. This is just one example of the many wild swings seen in the market lately, off the back of misguided news headlines.
It's a short-term market
What is clear however is that the market is looking ultra short term, with every single view point from officials being disseminated into what the wider implications could be. What would the knock-on effects be if there was a slight change in policy, or even central bank rhetoric? These jitters are a sign of a very nervous market and, are in some ways, justified. The worst-case scenarios that could play out if Italy is seriously a potential default candidate don't even bear thinking about.
Looking beyond the market noise
Looking through the noise though, contrarians may question whether this could be a great buying opportunity for those looking for an investment, and not a two-month trade. There is every chance that Greece will have to restructure in the next twelve months, and Portugal and Ireland will demand the same treatment. However, the worse the situation becomes, the closer we get to fiscal unity (a eurobond) and, therefore, a resolution. The probability is that the US won't go into recession, but will experience sluggish growth. At the end of the day, everyone is bearish; the correlation between Australian and US blue chip stocks is around 80%, fundamentals are out the window with a rising tide lifting all ships, short interest has picked up and confidence is shot to pieces. This is all evident while everyone is in cash, with US institutions having their lowest exposure to stocks on record. These are all contrarian indicators that suggest a bottom could be in sight.
Potential short-term trades
The bottom line is that if you are willing to look beyond the short-term noise that is driving the market, there is probably a good case to say equities will be dramatically higher than they are now in a year or so. However, it is traders and more so computers (high frequency) that are driving price action. Those that step back from this could be nicely rewarded in time, despite the lack of near-term clarity. However, this would be a pure contrarian play, and one for the brave.
The short-term equity traders out there though, will need to keep a close eye on key technical levels in the market. On the S&P, the index looks set to break the uptrend support from August 9, which, if this gives way, could indicate a move down to 1101 (the August 9 low). If it breaks this level, things could get a little uglier. On the ASX 200, the key level to watch is 3765 (the August 9 low). While perhaps from a fundamental view, a lot of the bad news is priced in, though the technicals may be suggesting we could see lower prices in the short term.
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Updated: 23/09/2011
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