Aug 9, 2014

The Events that Broke the Back of the Bull

The event that turned the tide of the global stock market
Rob Stothard—Getty Images
The global stock market seems to be unstoppable come July 2014. There are some analysts citing that "Selling in May and Go Away" is dead as there was no immediate risk to the global economy. The US economy is growing at last with all major indicators on a rise. The events over at Ukraine had been glossed over as immaterial and the Europe central bank affirmed their decisions to keep interest rates low. Investors were positive over at Asia as China and India seemed to have gotten their economy into order. All was well, until a stray missile shot down an airline passenger.



Suddenly, the threat of a repeat of the Cold War seems to be possible again and the European stock market corrected sharply in anticipation of the sudden threat of a sanction war. Following the events of MH17, the Argentinian government was forced to default on their debt, due to a legacy issue from the 2001 Argentinian debt crisis. Shortly after, Portugal's second largest lender: Banco Espirito Santo nearly went bankrupt due the losses incurred by the rising amount of bad debts it was holding. The Portugal's central bank promptly bailed the bank out to prevent another potential repeat of the contagion effects of Lehman Brothers crisis.

With all these negative events happening within a short span of a few days, investors' confidence were shaken, but not broken yet. Two piece of economic news tipped the balance at the end of the day. A series of strong economic data from US lead to a fear of the US Federal Bank rising interest rates earlier than expected and weak inflation figures from Europe leading to a fear that the European economies might fall into a Japanese like deflationary spiral.

The curious thing to these 2 pieces of news, would be interpreted differently if they were to occurred a month ago. Strong US economic data should buoy the US stock market to rise as it will result in stronger corporate profits, while a low inflationary figure from Europe means that the European Central Bank can afford to keep its interest rates low longer. Low interest rates are often good news for the stock market.

The only analogy that I can think of, to explain this investor psychology is akin to a person watching a horror movie at night. With the fear of ghosts and zombies hiding behind doors and jumping out of the closet, every shadow at night seems to be much more fearsome than usual. This is similar to the psychology of the current stock market. The investors' perception, once spooked, tends to find negative association with every event, which could used to be a positive association.

The global stock market has fallen 4-10% since the last week of July, with the European markets bearing the brunt of the damage. It is still too early to call for a market correction yet, as the Bulls haven't really given up the strong rally which they have enjoyed for the last 3 years. However, a stray missile from the Russian backed Ukrainian rebels had started the wheels of a possible 10% correction into motion.

Strategy from Here

I have been asked why I have divided the equity portion of the portfolio equally among all 3 geographic sector. My rationale is simple: The global stock market is due for a market correction but I am not sure where will the origins from. At the point of time when I plotted my strategy, the US stock market seemed to be over-valued and has a high probability of being the first one to fall. The European economies seem to be growing nicely but the problems associated with the European debt crisis have not gone away yet. Besides, the European stock market had performed strongly during 2013 and is on the high side at that point of time. Concerns about the rising debt issue with China and the impact of a rising interest rate in an overheated Asian property market could also spark off a global crisis. However, the Asian stock markets had performed horribly during 2013 and is pretty undervalued compared to the Western stock market. With all these concerns in mind, I decided to adopt a shotgun method and allocated equally to all three sector. Interestingly, the "safest" zone: Europe, is the one that lead the fall of equity values. The market often hits you at the side where the most unexpected.



My strong advocate for USD denominated cash holdings has paid off at last, with USD/SGD appreciating 1% in the past 2 weeks. I will make use of this small correction to slowly reallocate the cash holding back into equities. I have not really decided on which area to move into, but the area with the greatest risk seems to be that of the best potential: Europe.

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