Two weeks ago we posed two questions, was Blackstone’s decision to sell their shares to the public a symbolic signal of a market top and was Richard Russell’s move from an extremely bearish view of equities to an extremely bullish one another signal because it is said, bear markets start or, in this case resume, once the last bear turns bullish.
Since then the Shanghai stock market has seen a significant sell-off; initially largely ignored by the rest of the world. It started once their government increased stamp duty from 0.1% to 0.3%. Their objective of cooling the stock market worked a bit too well; the market was down 13% in just a few days and on two of those days, down by 6% and 8%. Now the Chinese government, alarmed by the fall, are sponsoring media statements in support of the market.
Back in February, when the Shanghai stock market last suffered a severe sell-off, other global stock markets immediately and dramatically responded, on one day the Dow fell over 400 points. Following this, stock markets forged ahead again. This time round the market seems to have thought “fool me once, shame on you; fool me twice, shame on me”, assuming that this is an unpleasant but temporary pull-back as part of a continuing bull phase. If so, Chinese and other Asian markets will again become strong buy-opportunities. Alternatively, this may be the start of something big, leading at least to considerable corrections in most global stock markets. Central Banks, with their tightening interest rate policies are determined to slay the inflation dragon and in so doing they will very likely undermine asset markets such as property and equities.
Strong signals from buy-to-letters
The UK housing market is creaking and there are some important signals. A sharp slow-down has been reported in buy-to-let purchases coupled with a big increase in buy-to-let property offered for sale, this is hardly surprising bearing in mind that rental yields are pathetically low; after taking account of voids and other ownership expenses, rents are insufficient to cover interest rate charges. According to the Royal Institute of Chartered Surveyors (RICS), the proportion of buy-to-let investors selling their property at the end of their tenant lease has jumped to 5.2% in the first quarter of the year, from 4.1% for the last quarter of 2006. Tim Hyatt, Head of UK Letting at Knight Frank, the Estate Agency, told the Financial Times that 10-15% of their lettings are being put up for sale in the last six months or so, whereas normally this figure is very minimal.
David Stubbs, RICS Economist says buy-to-let rents are rising just as they did in the late 1980s, prior to the property collapse then. Buy-to-let properties are being sold and not surprisingly this is reducing the supply of rented accommodation, demand for rented property is rising as it becomes more obvious that the property market is in difficulty.
If the Daily Telegraph is right in recently reporting that the UK housing market is over-valued by up to 20%, then the scale of down-side is very considerable because bubble-type prices always go too high, e.g. 20% over-valued, to then fall back too far. Based upon past experience, from current prices, a 40% downside is therefore feasible. Estate agents across the UK are seeing a substantial rise in the number of properties coming up for sale.
Equity markets overvalued
A number of high profile analysts have expressed concern about equity market values. The latest being Teun Draaisma, Chief European Strategist at Morgan Stanley, he says “There’s a triple warning that is very powerful and has only been triggered five times since 1980.” Ambrose Evans-Pritchard, in the Daily Telegraph, on the 6th June, reported him as saying “Interest rates are rising and reaching critical levels. This matters more than growth for equities, so we think the mid-cycle rally is over. Our model is forecasting a 14% correction over the next six months, but it could be more serious.” He also said “Investors are taking far too much comfort from global liquidity. Markets always return to fundamental value, people could be in for a rude awakening. This is the greater fool theory.”
As we have reported several times recently, this is the second longest period since 1929 without at least a 10% correction for the American stock market. A correction is due, so Morgan Stanley’s 14% does not seem out of the way at all. We would say that if a correction does start to develop, we would expect it to be much worse than 10%.
Our Four Horses of the Financial Apocalypse could well be on the edge of freaky behaviour, led by the white horse. In this issue, there is not a lot new to say about three of the horses, so we will concentrate on just one.
Market volatility: The Volatility Index (VIX)
For a number of issues we have been identifying the level of 16 as a key alarm signal for asset markets. However, a secondary level of 14.6 has formed which has taken on some significance and was, on the 6th June, exceeded to the upside. If we now see the level of 16 exceeded then events could move on quite unpleasantly for stock markets, particularly as this Index is central to the methodology used by financial institutions to monitor the risk that they are taking on, called “Value at Risk”. The higher the level of market volatility, and the VIX is a measure of that volatility, the greater the VAR.
If events are really going to move on in the way we think is possible, then the Carry Trade will start to unwind seriously and an indicator of that will be a rising Japanese yen and Swiss franc. They will both benefit to the upside as a result of loan repayments as Carry Trade investors sell the assets they have bought, to repay the yen and Swiss franc loans used to finance the purchase of those assets. A combination of VIX, yen and Swiss franc strength might certainly frighten our other three Horses of the Financial Apocalypse.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/