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WEEKLY MARKET REPORT: Is a coming US recession fully priced in yet?

SINGAPORE – By now, you’d have to wonder whether an aggressive cutting of US interest rates really is the answer, or instead of doing so and inflating yet more bubbles the best medicine for an ailing US economy is to simply let its excesses and imbalances correct themselves, lengthy though the process may be.

Financial markets however – like funds managers – are typically short-sighted when it comes to suffering pain, so for now, the pressure is on the US Federal Reserve to cut its fed funds rate by 50 points at the Jan 30 Open Markets Committee meeting – after Friday’s rout on Wall Street, the futures market priced in a 60 per cent probability of this occurring.

You’d have to wonder if this would really be of any help, given that rates have already been lowered by 75 points in the fourth quarter but the markets have not recovered.

You’d then have to wonder whether it’s the economy that comes first or the stock market as far as the Fed is concerned, though this being an election year the answer is that propping up both must surely be priorities because there’s nothing like those large plus signs next to the major indicators and indices to inject confidence into the population, even if it is misplaced.

Speaking of which, you’d have to conclude that the large plus signs next to the Straits Times Index in 2007’s final fortnight were most probably thanks to a combination of window-dressing and the ‘buy in anticipation of window-dressing’ that we suggested would take place in this column a fortnight ago.

Readers might also recall that the full suggestion made back then was to buy in anticipation the large index blue chips such as SingTel, the banks, SGX and Keppel but to quickly sell into strength because the likelihood of a rally heading into the new year was slim.

In other words, the best bet for the time being is to trade the market, buying selectively into dips but selling as quickly as possible into strength.

It goes without saying that the same strategy should apply for at least the next two weeks, at least until the days leading up to the Jan 30 FOMC meeting when another ‘buy in anticipation, sell on news or into strength’ window should present itself.

One main reason for this is that by now, 50-75 basis points interest rate cuts during the first six months of 2008 must surely already be in the price. Markets have for a long time been clamouring for aggressive cuts and as stated earlier, this being a US election year, it’s difficult to see the Fed resisting. So even though there will be interest rate-led bounces before and after each FOMC, it’s likely they will not last long.

The second reason is an extended recoupling with Wall Street, or rather no sign of any decoupling as some analysts had predicted. Linked by programme trades, all markets in this part of the world have shown an increasing – not decreasing – dependency on the US for direction over the past six months and there’s no reason to expect any change soon.

In fact, recoupling is very much a theme in Morgan Stanley’s Critical Macro Investment Themes dated Jan 3 by chief economist Richard Berner.

‘Although it has yet to begin, our call for a mild US recession is intact: we expect domestic demand to contract significantly in each of the next three quarters, essentially no growth in overall GDP for the year ending Q3 2008 and earnings to contract by 5-10 per cent over that period…global recoupling may well be a dominant theme this year’ wrote Mr Berner, who unlike most other analysts, believes the US dollar will strengthen in 2008.

One problem is that Wall Street may not have fully priced in the risk to earnings bought on by theĀ coming slowdown and that other markets are still overly complacent about their own impending slowdowns and earnings forecasts.

Still, the volatility that is very likely to result from all this uncertainty will create plenty of trading opportunities (structured warrant issuers, whose instruments thrive in volatile markets, must be rubbing their hands in glee) for those with the stomach for heightened risk.

The upshot of all this is that all markets will be stuck in a trading range for a while yet, there is no decoupling from Wall Street yet on the horizon, technical factors like supports and resistances will become important, there’s a strong likelihood that a coming US slowdown is not yet in local prices and investors should take overly bullish call to keep buying with a healthy dose of salt.

 

Source: Business Times 5 Jan 08

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