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Sat 7 Nov 2009 04:00 AM

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A second crash?

Amid signs that green shoots are beginning to wilt, investors are worrying that global bourses may be headed for a crash.

A second crash?
A second crash?
Billionaire George Soros thinks the global economic recovery will ‘run out of steam’, and a ‘double dip’ recession may follow in 2010 or 2011.
A second crash?
China is projecting an eight percent growth this year on the back of its $585bn stimulus package.
A second crash?

Amid signs that tentative green shoots are beginning to wilt, investors are worrying that global stock markets could be headed for a sharp correction.

News that the world’s largest economy has pulled out of the recession was cheered by US traders, who pushed the Dow Jones Industrial Average up by 200 points, or 2.1 percent, to 9,962.58 on October 29, the day of the announcement.

“This is obviously welcome news and an affirmation that this recession is abating and the steps we’ve taken have made a difference,” president Barack Obama said after the release of data showing that the American economy grew by 3.5 percent in the third quarter this year.

But in a sign that investors remain doubtful over the strength of the recovery, the Dow Jones measure reversed those gains the next day, dropping 224 points, or 2.3 percent, after a sell-off in the financial sector.

In a tumultuous week, the other key US benchmark, the S&P 500, snapped a seven-month winning streak that had taken it 60 percent above its March low.

Positive news flow included earnings from Intel and JP Morgan Chase that were above expectations.

Some observers wrote off the souring mood as another bout of panic on Wall Street. To be sure, investors are anything but calm these days: the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, often referred to as the stock market’s fear gauge, topped 30 more than once during the week. VIX values above 30 are associated with a high degree of investor fear or uncertainty.

Others are more bearish.

Billionaire George Soros told university students in Budapest that the global economic recovery is “liable to run out of steam”, and that a “double dip” recession may follow in 2010 or 2011.

Sceptics say that stock prices have been propped up by the government’s stimulus spending and that they could come back down after it is unwound.

They also argue that the higher-than-expected rise in GDP was mainly due to Cash for Clunkers, the $3bn federal scrappage programme that provided economic incentives to consumers who wanted to buy a new, more fuel efficient vehicle.

According to the Bureau of Economic Analysis, a US government agency, spending on durable goods, which includes car sales, soared 22.3 percent in the third quarter, compared with a 5.6 percent decline in the previous quarter. Fourth quarter numbers will not just be without that boost, auto sales are also likely to fall below the seasonal average after prospective car buyers scrambled to meet the Cash for Clunkers deadline.

Another billionaire financier, Wilbur Ross, added to the gloom by predicting a collapse in US commercial real estate prices. “All of the components of real estate value are going in the wrong direction simultaneously,” he told newswire Bloomberg on October 30. “Occupancy rates are going down. Rent rates are going down and the capitalisation rate — the return that investors are demanding to buy a property — are going up.”

US investors are also concerned with the prospect of another jobless recovery, like the one that followed the dot com bubble. That recession ended at the end of 2001, but job growth did not take place until 2003. If the same were to happen after this, much deeper recession, the impact on consumer spending could be severe.

So if the US sneezes, will the rest of the world catch a cold?

“There is definitely a correlation with the Gulf, it is very obvious right now. In 2008 and at the end of 2007 there was correlation with the global markets, but only on extreme down days. We saw that changing after the credit crunch,” says Ahmad Shahin, strategy head at Shuaa Capital’s research department.

Over the last month, the investment bank has been advising clients to get out of the stock markets ahead of what it anticipates will be a correction, but not a crash.

“We believe that it’s very healthy for the markets because at the end of the day they did have a very strong rally since the bottom in February and March up to last month. But we do not think that there is going to be another crash anywhere near what we saw last year. We do believe that the worst is behind us, definitely,” he says.

The Dubai government’s first bond sale in more than a year and narrowing spreads on its credit default swaps indicate that international investors are gaining confidence in the emirate’s recovery prospects. Oil prices hovering around $80 per barrel should also help buoy the region’s stocks.

GCC stock markets continued to rise in the third quarter, albeit at a slower pace than in the first half. MSCI GCC, a measure of the Gulf’s bourses gained 13.2 percent in the quarter, led by a 35.7 percent quarterly gain in the MSCI UAE index. Laggards were MSCI Kuwait, with a gain of 4 percent, and MSCI Bahrain, which lost 10 percent in the period.

According to research by Kuwait Financial Centre Markaz, fund managers in the region continued to raise their exposure to equities in the quarter, increasing allocation to 88 percent in September from 83 percent in June, while exposure to cash was reduced to 10 percent from 16 percent.

Third quarter earnings have offered more green shoots, but no fully fledged recovery, leading to volatile trading.

The Dubai Financial Market (DFM) cheered when
Emirates NBD

, the UAE’s largest lender by assets, reported a 3.4 percent increase in third quarter net profit, beating analyst forecasts. Dubai bellwether

also surprised on the upside, as it returned to profit after writing down the value of its US operations in the previous quarter. The largest investment bank in the country,
Shuaa Capital

, failed to do the same: its third quarter loss sent the shares down by almost ten percent on the day of the announcement.

“We came into the earnings season and people were expecting that earnings results would show that we are out of the woods,” says Fadi Al Said, head of equities at ING Investment Management Middle East.

“I think some of them did show good improvement. However, other results showed that there is some stress here and there. Or even if it met the consensus, it didn’t meet the kind of expectations that were built into prices before earnings.”

A similar slump took place in July after the second quarter’s earnings were released, he points out.

Still, he doesn’t rule out a second crash, as predicted by Soros. “It’s very hard to call whether it’s going to be a second crash or a second correction. Although it’s very hard to say, I’m leaning more towards a second correction,” says Al Said.

“We saw hedge funds increasing their exposure to the region. There were a lot of expectations that we are going to get out of this as soon as possible and people started to get excited. We almost reached a euphoric state, and usually when you have this kind of consensus and excitement, the other thing happens.”

Investor jitters are to blame for a lot of the extreme movements currently being witnessed, he argues.

“The problem now is that people get a little bit more stressed when they see that things are happening in the West or in other emerging markets. They are watching that carefully. They think they have learnt a lesson, so they are very easily triggered to pull the switch off, to jump ship.”

Al Said believes the DFM will find a support level at 2000 points or in a worst case scenario, at 1800 points. “If it’s going to be an extreme correction we might go there. I hope we don’t break below 2000 points. I still have hope that it’s not going to be a very severe one.”

Often, the pace of the decline is more important than the magnitude, he adds. Banks and investors may not be able to absorb a rapid stock market decline, but over a longer period of time most economies can digest it.

ING Investment Management Middle East believes the same will hold true for Dubai’s real estate market going forward.

Looking East, Gulf investors eyeing the relatively resilient Asian markets are also taking a cautious stance. One of them, Kuwait China Investment Co (KCIC), is hoping to profit from rising consumer spending in China and India once their economies have bounced back. Recently, the firm has been hoarding cash.

“Asia has recovered incredibly fast, much faster than the West, but we are worried that it’s a liquidity rally that’s taking place, and so we have actually taken risk off the table and we’re sitting on significant cash. We think that there is a correction in the pipeline,” says managing director Ahmad Al Hamad.

The second wave of liquidity to have hit the global economy is not unlike the one seen in 2007, even if it manifested itself differently, he claims. “What we are seeing is a wall of liquidity that is driving up asset prices without real demand,” he says.

The Chinese government is projecting eight percent growth in the world’s third largest economy this year after launching a $585bn stimulus package. But the trade imbalance between the US and China that economists have been fretting over for years has yet to be addressed. Chinese consumers still do not have enough money in their own hands to insulate the country from a slowdown in major export markets like the US and Europe, and the yuan remains artificially low.

“We look at market fundamentals in what makes a fundamentally stable market, and we don’t think that this liquidity reflects real demand. Sure, profits have been positive or at least improving quarter on quarter in certain companies, but it doesn’t reflect top line improvement. It reflects cost cutting and potentially even consolidation within industries,” says Al Hamad.

The Chinese government has taken steps to bolster domestic consumption. In January, it launched a $124bn healthcare plan that aims to provide basic health insurance for 90 percent of its citizens by 2011. Analysts believe that overhauling the country’s social welfare system is key to strengthening consumer spending, and reducing dependence on the American consumer. But it is a process that is likely to take time.

“I think everyone sees Asia as the hopeful future in terms of real demand, but it’s not an overnight transformation. So we worry about this recent rally,” says Al Hamad.

“The longer it takes for this to correct, the harder the fall will be.”

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