Rally in reverse gear

The fear of an economic meltdown no longer exists.

LAST month, the US stock markets were officially out of the bear market territory. All three major indexes, the Dow Jones Industrial Index, Nasdaq and S&P 500, rose above the March 2020 levels, shaking off the Covid-19 blues.

It has been one of the shortest bear market slumps in the history of capital markets.

Fuelled by a combination of low interest rates and central banks pumping unlimited liquidity to keep the financial system afloat, all asset prices went up.

Technology and healthcare stocks led the charge. Commodities and even junk bonds received a boost from the policy of central banks to embark on low interest rates and to pump money into the system.

In March this year, central banks feared an economic collapse as daily business activities came to a significant slowdown due to the pandemic.

The fear of an economic meltdown no longer exists.

Since May this year, anyone who has had a bearish view of the stock market would have been living a lonely life. Even the most conservative of fund managers who feared the economic meltdown had to eat humble pie as stock markets around the world roared back.

Low interest rates, low economic growth rates and expectations of low inflation rates pushed down yields on risk-free government bonds to historical low levels.

For instance, the Malaysian government launched Islamic bonds offering a profit rate or return of a mere 2%. The US 10-year paper is trading at a historically low yield of 0.64%, while the Malaysian 10-year government paper is also at a low of 2.56%.

Low returns from risk-free investments prompted people with extra cash to put their money in the stock market and other assets in search of higher returns.

Property did not benefit from the cheap money exuberance because it is not an easy asset to buy and sell. Assets related to tourism, travel and finance sectors also did not see recovery in their prices.Just when all seems to be going well in the new norm of Covid-19 era, stock markets are going into reverse gear.

Technology stocks, which lifted the rally in the United States are taking a beating on the reasoning that valuations are simply too high.A case in point is Tesla, the electric car manufacturer based in California, which has increased more than 380% year-to-date. It defies logic how the valuation of a car manufacturer that produces only 500,000 vehicles per annum and scarcely makes a profit can be higher compared to the likes of Toyota which is highly profitable and produces 10 million units per annum.

On the domestic front, news of the US distributing vaccines on Nov 1, just two days before the presidential elections there, are reasons enough for funds to sell their glove stocks and re-position their portfolio.

Glove stocks are on a retreat after a fantastic run since April this year.

Some have described the retreat of glove stocks as a sign of fatigue after having gone up so much since April.

But the naysayers feel that the best days of glove stocks are over considering a vaccine is closer to being commercialised.

What’s interesting is that the reason traders cite for taking money off the table in the technology-led US stock market run is the political uncertainty ahead of the presidential election on Nov 3. The concern is that the US political scene could become ugly post the presidential elections if the results were to go down the wire.

President Donald Trump is facing a stiff challenge from Joe Biden and increasingly expectations are that the election results could be disputed.

November is also an important milestone for Prime Minister Tan Sri Muhyiddin Yassin’s Perikatan Nasional government. His leadership has increasingly come under criticism by top Umno leaders.

The Umno critics of Muhyiddin want a snap general election to be held as soon as possible as they are confident that a general election would pave the way for the return of their party to helm the federal government. Umno in partnership with PAS has formed Muafakat Nasional, which has won all the last seven by-elections.

Muhyiddin’s Bersatu is a combination of former Umno members and a breakaway group of Keadilan MPs led by Datuk Seri Azmin Ali. It is perceived as dependent on Muafakat Nasional to stay in power.

Hence, speculation is rife that Muhyiddin may dissolve parliament in November if he senses that support towards Budget 2021, that is to be unveiled on Nov 13, is not forthcoming.

Muhyiddin knows how much goodwill he can earn from feel-good policies. For instance the six-month blanket moratorium for all borrowers on repayment of housing, hire-purchase and personal loans has earned him brownie points after taking over from Tun Dr Mahathir Mohamad in March this year.

A budget with plenty of goodies for the people may work well for Muhyiddin to firm up his position among the Malay and some segments of the non-Malay voters, should he call for general election.

To the seasoned stock market traders, the political uncertainties are just the excuse needed to sell down on over-valued stocks.

In the US, the contracts on “put option” of technology stocks have increased for the months of October and November. This is in contrast to the situation two months ago where traders were buying “call options” of tech stocks on expectations of rising prices.

Options are instruments of seasoned investors and traders. By buying a call option, the trader locks in the price of the stock that he or she can purchase in the future. A trader buys a call option if the view is that the stock price will rise in future.

The reverse is a put option, which is an instrument that allows the holder of the option to sell the stock at a certain fixed price in the future. The put option is generally to hedge against any downside risk of the stock.

Options are not popular in Malaysia unlike in other developed markets such as the US. It is an instrument that detects the immediate trends of the capital markets.

At the moment, the number of traders who have bet against tech stocks are on the rise. This does not spell good news for Bursa.

The rally this year is led by the tech and glove sectors. If both sectors are no longer sexy, the pain inflicted on Bursa can be hefty.

M. Shanmugam is former specialist editor of the Star. The views expressed here are the writer’s own.

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