ERNEST LIM: Reasons for selling into the current rally

This article was posted on remisier Ernest Lim's blog, http://www.ernestlim15.blogspot.com/, over the weekend and is reproduced with permission.

Ernest Lim

LAST WEEK, Asian stocks posted their sixth weekly gain, the longest winning streak since 2010 amid a dovish Federal Reserve and optimism that Greece would successfully negotiate a deal with the private creditors.

The STI has surged 10.2%, or 270 points, in the year to date (STI closed at 2,646 on 30 Dec). The STI may go higher early this week and challenge the gap 2,943 – 2,974 (formed on 5-8 Aug 2011) due to two possible factors viz:

a) Greek debt talks crystallised and an agreement is formed; or / and

b) China eases its monetary policy by lowering its required reserve ratio, or enacts other measures.

However, once the initial euphoria over the above measures cools off, we may have to contend with what the credit rating agencies have to say on the Greek debt talks and whether this constitutes a default.

Secondly, there is a multitude of economic reports this week, especially on the U.S. market. Recent better than expected economic data have pushed the “bar” higher for subsequent economic data and odds are pointing that going forward, the U.S. economic data may not surprise on the upside.

 I believe that markets may have gotten ahead of themselves and the STI is likely to be lower in 1Q / 2Q, in view of (but not limited to) the challenges below:

a) Avalanche of Euro debt refinancing in first 4 months of the year. Although yields have fallen sharply in the recent debt auctions, it is noteworthy that the yield comparisons are done against a high base.

Once the base normalises, the “better than expected” sentiment is likely to fizzle out.

Secondly, it is still questionable whether the drop (albeit smaller in extent compared to short term bond yields) in bond yields on the longer dated debt > 3 years (ECB only provides max 3 year loans) are sustainable.

This is because for long term debt, investors prefer nations that strike a balance between austerity measures and pro-growth policies. Thirdly, debt yields which have fallen recently are still high relative to historical standards and this would still exert a drag on the countries’ finances.

b) Singapore GDP probably bottoms in late 1Q or 2Q. Usually, equities markets bottom around the same period or slightly ahead of the bottom in GDP.

c) U.S. economic reports may be weaker going into Feb onwards. It is noteworthy that some of these recent stronger than expected economic data are due in part to special one off factors. For example, business spending has been greater than expected, primarily because a tax incentive for capital spending that expired in Dec 2011.

d) The 17 nation eurozone is almost certainly in a recession. On 24 Jan, IMF reduced its 2012 forecast of the 17 nation eurozone from 1.1% (which it forecast four months ago) to -0.5%. As the eurozone accounts for 20% of global output, this is likely to provide a drag on other economies such as Singapore, China, Taiwan etc. Coupled with the potential slowdown in U.S in 1H, this does not bode well for the equity markets in 1H.

e) Less upside guidance from companies: Most companies are likely to be affected by the European debt problems; slowdown and tight lending conditions in China and slowdown in U.S. to various extents.

According to Reuters, without Apple, this quarter would have been a fairly lacklustre earnings season. Since the start of results season to 25 Jan, 57% of companies that reported results have exceeded estimates, which was less than the average beat rate of 70%. Going forward, 1Q2012 results to be reported in Apr / May may not be that inspiring.

If the above is true, that we should sell in this recent rally unless u are less than 20-30% invested in the market. We should conserve at least 50% of your investable cash to buy into blue chip counters on sharp drops. Typically, blue chip stocks move first (and more) than small caps in the event of a rebound.

Lastly, it is extremely important to note that the above is my personal opinion and may not cater to your specific risk profile etc. The question of when to buy / sell and what to buy / sell differs greatly from individual to individual.

Furthermore, it is extremely important to bear in mind that the market outlook is never static. It can change suddenly if there are sudden big events unfolding from the market – some events can happen as quickly as overnight.

STI supports and resistances based on the close on 27 Jan are:

Current: 2,916.26

Support 1: 2,905

Support 2: 2,877

Support 3: 2,855

Support 4: 2,839

Resistance 1: 2,935

Resistance 2: 2,943

Resistance 3: 2,974

Resistance 4: 2,997

*Supports and resistances are not static levels. They may be subject to change daily.


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