STI approaching level of last major peak

With the Straits Times Index (STI) closing at 2,168.86 on Friday, the Singapore market is around levels not seen since 2000, the year of the last major peak. Is the Singapore stock market ready to scale new heights? Or are we nearing a new peak?

To have an idea, let us first look at the economic backdrop.

The Singapore economy grew 7.9 percent in the fourth quarter on an annualised quarter-on-quarter basis. Manufacturing was the strong driver of growth in the fourth quarter, rising 14.1 percent over the previous year, with biomedical manufacturing outstanding.

The outlook for 2005, however, is for slower growth. The Ministry of Trade and Industry expects growth of 3-5 percent. Reflecting this slowdown, the composite leading indicator fell 1.9 percent in the fourth quarter over the previous quarter, following a 1.2 percent fall in the previous quarter.

Electronics, is likely to be a major victim of the slowdown. Non-oil domestic exports decreased by 0.6 percent in January on a month-on-month seasonally-adjusted basis, following a revised 0.2 percent rise in December, with electronics in particular rising only 5.9 percent from a year earlier after an 8.3 percent growth in the preceding month. Non-electronic products, though, grew 12.4 percent last month, thanks to strong exports of petrochemicals, electrical machinery and raw chemicals.

An outright downturn appears unlikely at the moment. The trade picture shows that non-oil retained imports of intermediate goods, a short term leading indicator of overall manufacturing activities in the months ahead, rose 8.8 percent on a month-on-month seasonally-adjusted basis in January, reversing the revised 3.7 percent contraction in December 2004.

The trend in the economy has analysts recommending investors move to the domestic sector, for example, property, banking and retail.

The property sector has seen particularly buoyant sentiment. This has often been fed by property companies themselves.

CapitaLand chairman Richard Hu was recently quoted in The Business Times as saying: "The outlook is positive given the growth in real estate markets in Asia, and we are well positioned to take advantage of this growth."

In the same report, the newspaper mentioned that Keppel Land is expanding into the property markets of China, Thailand, Vietnam, Indonesia and India, and also expects to see stronger growth in Singapore's residential and property market this year.

Both CapitaLand and Keppel Land recently reported a good sets of results for 2004.

The main risk for property stocks is the possibility that the good prospects for the sector have been discounted by investors. Remember that the Property Index outperformed the STI in 2004 by one percentage point and has outperformed the STI by about the same margin so far in 2005.

In contrast, the Finance Index underperformed the STI by about 7 percentage points in 2004 and continued to underperform the STI by about 3 percentage points in 2005 so far.

In even greater contrast is the Electronics Index, which underperformed the STI by a whopping 24 percentage points in 2004, reflecting the current malaise of the electronics sector, and continued to underperform the STI by almost 7 pecentage points in 2005 so far.

Indeed, many people think that while the electronics sector may be seeing a slowdown, things may turn up towards the end of the year. If that is the case, it may be about time for electronics stocks to start outperforming the rest of the market.

But what is the outlook for the market as a whole?

Interest rates have been rising and the yield curve has been flattening since around the middle of 2004. This trend is likely to persist. Such a trend is bad for the economy, but more importantly, it is bad for the stock market as well.

Asia-Pacific stock markets are generally perceived to be more resilient than US stocks. However, in a survey by Merrill Lynch recently, fund managers were found to be underweight on Singapore.

I had previously indicated that at the start of the last bear market in early 2000, the STI had found support at around the 2,000 level. I had thought that this provided a technical basis for the bull market to end with the STI below 2,000. With the STI now trading significantly above 2,000, this forecast has to be reviewed.

While the STI had found support at around 2,000 at the start of the last bear market, it had also found resistance at around 2,200. Can this be a target? It is only about 2 percent higher than Friday's close.

If the market breaks this level, then the next likely target is none other than the peak of 2,583 hit on the very first trading day of 2000. Now that's almost 20 percent higher than Friday's close. A mouth-watering prospect.

But is it realistic?

Will investors turn chicken in Year of the Rooster?

Global stock markets have turned in mixed performances so far in 2005. Bullish investors hoping that early 2005 returns would form the basis for further gains in stocks for the rest of the year may be disappointed. And with bond yields low but short-term interest rates rising, investors may be forgiven for thinking that the investment outlook is poor for the Year of the Rooster. However, expert opinions remain highly divided.

The Chinese Year of the Rooster begins on 9 February. So far, European stock investors have the best reasons to crow.

	Close on 31 Dec 2004	Close on 4 Feb 2005	Percent change
S&P 500	1,213.55	1,203.03	-0.9
Nikkei 225	11,488.76	11,360.40	-1.1
Hang Seng	14,230.14	13,585.17	-4.5
Straits Times	2,066.14	2,113.58	2.3
FTSE 100	4,814.3	4,941.5	2.6
DAX	4,256.08	4,339.28	2.0
CAC 40	3,821.16	3,958.01	3.6

Where are stock markets likely to go from here?

Rising interest rates suggest that markets will go down. The Federal Reserve has been on a tightening cycle since the middle of last year and, just last week, raised the federal funds rate again to 2.5 percent.

And yet, interest rates remain low and the yield curve steep compared to historical norms. In the past, these have often provided good conditions for higher stock valuations.

As for the economy, most economists expect moderation in the coming months. A global all-industry index produced by JP Morgan edged lower to 57.1 in January from 57.2 the previous month. Its global manufacturing PMI was also slightly down based on its latest revised series, from 53.3 in December to 53.0 in January.

"The latest output indexes are consistent with annualized growth of approximately 3.5 percent in global GDP and 2 percent in global industrial production," said David Hensley, director of global economics at JP Morgan, in New York recently.

Such rates of growth should not preclude gains for stocks. But they don't guarantee it either. Columnists at CBS MarketWatch have of late argued for both.

Herb Greenberg, a senior columnist at CBS MarketWatch, wrote in a commentary on 4 February entitled "Investors ignore risk, reach for return" that investors might be too complacent.

"If markets climb a wall of worry, as the old adage goes, they collapse on a crevice of complacency," he wrote. "From my perch, the complacency in a wide variety of names, many of which show up in this column, hasn't been this pronounced since 1999 to 2000. There's simply little in the way of respect for risk, which is why I call this the no-fear phase of this market's cycle."

However, Mark Hulbert, editor of Hulbert Financial Digest and fellow columnist at CBS MarketWatch, thinks otherwise.

In a commentary entitled "The retreat of the bulls" on 2 February, he points out that the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average stock market exposure among some short-term market-timing newsletters, has dropped from 59.2 percent in late December to 23.5 percent. Other indicators like the Hulbert Nasdaq Newsletter Sentiment Index and the American Association of Individual Investors' member survey also indicate large shifts in sentiment from bullishness towards bearishness.

Interestingly enough, Mark Hulbert appears to be saying the same thing about bonds, the usual alternative to stocks. He wrote in a 1 February commentary that "Bond advisers are too bearish right now". According to him, the Hulbert Bond Newsletter Sentiment Index (HBNSI), which represents the average bond market exposure among some short-term bond-timing newsletters, as of the end of January stood at negative 3.2 percent, which means that the average adviser among this group of bond timers is actually short the bond market.

However, CBS MarketWatch columnist Peter Brimelow and Edwin S Rubenstein, president of ESR Research, are not so sure. The latter two wrote a commentary on 3 February entitled "Bonds in uncharted territory" which said that if bonds do rally, it is likely to be for the short term only.

"The great bond bull market since 1980 is living on borrowed time," they wrote. "Our chart today shows that the post-1980 bond bull market is now already in territory uncharted in the past 100 years... There's room for a lot of play around these very long-term trends. But the end for bonds is nigh -- or the financial world is turning upside down."

However, the authors seem to be ignoring even longer-term trends. Indeed, the article provided data showing that $1 invested in bonds in 1801 would have grown to $122 in 1920 after adjusting for inflation. That's a real rate of return of about 4 percent a year. Since then, the value of the investment would have grown to $1089 in 2004 for a real rate of return of less than 3 percent a year.

No, the data actually show that bonds have some catching up to do. But that doesn't mean that it has to catch up anytime soon.

Contrary to what Brimelow and Rubenstein wrote, bonds might instead fall in the short term but rise thereafter. That is because while Hulbert may be correct in saying that bond traders in the US are short the bond market, the big players of today, the Asian central banks, are long -- very long see my previous
article "Explaining the fall in bond yields").

With the outlook so uncertain, I guess you can't blame investors who turn chicken on stocks or bonds going into the Year of the Rooster. Remember, the rooster may have wings but it cannot fly. Perceived potential for stocks and bonds gains may prove just as deceiving.