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Market price can be a liar

Investors in the past few months seem to have become more bullish and indicators of risks seem to have fallen one over another. The S&P 500, currently at 1,500, seems determine to challenge its all-time high of 1,565 reached in the heydays of the 2007 bull while our local FTSTI currently at 3,273, seems destine to challenge the key resistance of 3,300 (traced from the long 5-year up channel from the low of 1,456 reached on 9 March 2008) and likely to post a new high this year.

This current rally draws its strength from the European Central Bank’s (ECB) pledge to “do whatever it takes” in July 2012 to stem the European Crisis. Henceforth, most risk indicators have fallen like tenpins.

The Euro currency has risen by almost 12% against the US$ from the lows of summer 2012 and currency options indicate little fear on a falling Euro again. European sovereign-bond yields, long a source of anxiety, have eased substantially – for instance Greece 10-year bond yields has fallen from a high of almost 28% at the height of the European crisis to 10.7% presently. The Chicago Board Options Exchange Volatility Index (VIX), which most investors use as a gauge of market fear, has reached a 5-year low, at below 10.

Indeed, meaningful progress has been made in escaping the abyss of systemic risk that threatened to engulf Europe and key financial markets in 2011. It seems that risks have “skyfall” and financial markets have “lived to fight another day”, typical of most James Bond movies.

Nonetheless, to me, I would avoid growing complacent into this apparent stable financial environment./

The meager level of the VIX and record-low yields on credit-market instruments are largely linked to the US Federal Reserve’s (FR) and ECB’s expansionary monetary policies – together, both the FR and ECB have created a balloon of US$7 trillion of new money! Thus, to me, the VIX is being artificially depressed, and no longer as good a risk-indicator as it was before 2012.

In fact, the huge new monies created have led to what I would term as the “market price is a liar” as an indicator of risk post-European Crisis. To me, no market price is as dishonest as that of the US Treasuries, whose yields are being held down by the FR’s quantitative-easing program, in which the FR buys billions of dollars in government securities every month, and is set to continue till the US unemployment rate (which currently hovers at 7.8%) nears 6.5%, which to me may not materialize till at least 2015.

As an international investor, I shiver when the price of risk fail to reflect obvious financial realities.

During the Dot.com bubble in 2000, technology companies reached stratospheric valuations when entirely new valuation metrics like Price/Eye-Ball or Price/Number of Hits, were invented to justify those high prices. Of course by summer 2002, most technology companies have either vanished or dropped by more than 80% in their share prices. In the context of the local market, so-call Dot.com companies like Wiz Office and Ezyhealth have “wizzed” out of the local bourses.

At the start of 2007, with the US housing bubble at again stratospheric levels – home price/rent ratios, housing affordability, ease of refinancing etc, the VIX was at below 10, the lowest level since December 1993. Subsequently, the VIX surge to a high of 80 in 2012 reflected havoc and anguish in the credit markets as the US housing bubble burst and the credit markets froze.

Investors should always be cautious, based on these recent periods of economic and financial upheavals. The “market risk can be a liar” is something that we have to bear in mind as the price of risk can, at certain periods, be a non-reflection of true fundamentals.

My greatest grievance lies in the US, the father of capitalism – the current yield of less than 2% on 10-year Treasuries is totally disconnected from the current fiscal challenges, the slowing economy and the fact that this US$14 trillion economy faces a Debt/GDP of 370%! Other asset classes like equity3w, derivatives, money-market instruments take their pricing que from the 10-year Treasuries yield – thus, to me, they would lead to potentially disastrous pricing decision like equity risk premium and internal rate of return etc.

In the days of George Soros (who made a US$1 billion profit shorting the UK Pound in 1992), bond-market vigilantes and hedge funds helped to enforce tough fiscal and monetary policies discipline. When an economy ran an unjustifiable budget deficit, the vigilantes and hedge funds either sold their holdings, shorted the currency, or threatened to sell, raising the cost of issue debts.

In the financial system post-Global Financial Crisis, it works the opposite way. The massive liquidity pump by central banks during periods of distress and uncertainty creat rallies in bond prices in a Pavlovian way as investors flee from riskier assets like commodities and equities into bonds. This serves to reinforce further mispricing in government bonds and indirectly corporate bonds, which draw their yield pricing from government bonds.

As we approach another year of exceptionally low interest rates, which is a causative of the huge US$7 trillion massive new funds created, do we make the assumption that this scenario will persists?

As we have experienced so recently with the low price and easy availability of mortgage credit, “market prices can be a liar” and can quickly become complicit in both busts and bubbles market situations like the 2007 Global Financial Crisis.

I cannot help, but continue to wonder if the central banks’ campaign to depress interest rates is abetting dangerous buildup of government debt at prices totally detached from the true risk pricing position. I can only imagine the potential havoc financial markets will have to grapple with again when interest rates and risk swing up suddenly, which presently would rank as a “black swan” event in scenario analysis.

To me, there is nothing safe in today’s Treasuries yields, even though we were taught in finance and MBA schools that the Treasuries and Bonds are the safest asset class to have in one’s investment portfolio. To me, the current “market price is a liar”. You do not have to be James Bond to sniff this out.

Gabriel Yap
Gabriel Yap

Mr Gabriel Yap,CFA was an eminent stockbroker who retired from stockbroking in 2009 to devote himself to philanthropy to help the needy, poor and handicap globally. He has donated and assisted Charities Aid Foundation, Australia (CAF), a not-for-profit donor funds management business. CAF has granted over A$100 million in the past decade to needy organisations to undertake aid and charity work across the world.

Mr Yap is also Executive Chairman of GCP Global Pte Ltd, an investment firm that invest in both direct capital markets, bonds, real estate, commodities, foreign exchange and builds businesses. Mr Yap appears regularly for the TV media like Channel News Asia and Bloomberg and radio channels like FM93.8 for their various investment programs.

Previously Mr Yap has also lectured at renowned government institutions like the SEASEN Course for the Monetary Authority of Singapore and at Asian Development Bank. Mr Yap has also lectured at financial institutions like the Stock Exchange of Singapore, Institute of Banking and Finance, the Institute of Certified Public Accountants, the Singapore Institute of Management and the Securities Investors Association of Singapore.

In 2010, the venerable Reader’s Digest magazine created the Money Savvy column in their magazine, helmed by Mr Yap who writes on all things finance and answers questions from the magazine’s subscribers.

Mr Yap presently splits his time between Melbourne, Hong Kong/China and Singapore.