Connect

with Wisdom Capital:

Facebook

What might a contrarian do now?

20 Feb 2012 The Business Times By R Sivanithy, Senior Correspondent 2012 Singapore Press Holdings Limited FOUR weeks ago, this column suggested that contrarians had the market in their grip, particularly in Europe where stocks were turning in a stellar performance despite terrible economics ('Contrarians hold sway - for now' BT, Jan 16). It was also later suggested that because liquidity was high and as fund managers were fearful about missing out, stocks would remain well supported, though investors should bear in mind that Europe's debt mess was far from being resolved. ('Ample liquidity should provide support', BT, 30 Jan). Since then, the contrarian stance of being bullish in the face of a weak economic outlook has become the norm, with an increasing number of investors buying into the idea that Europe will somehow muddle through its debt crisis - that enough money will be raised and belts tightened, such that things probably can't get any worse than they were at the end of 2011. Ditto for the US, where there have been signs that the economy has bottomed. In other words, if December 2011 represented the bottom, then the only direction going forward must be up - or so the thinking goes. This argument is now being used to justify taking the plunge and it is today commonplace among many investors. Which then begs the question: if everyone believes the market will continue rising, what might be the correct contrarian play now? Might it perhaps make sense to quietly take some money off the table, especially since we're now seeing hectic churning of stocks below 0.5 cent, which suggests things are getting a bit overheated? There is, of course, still ample liquidity to provide some support. So maybe the preferred option would be to buy on the dips and to sell into strength. And although the market and the economy often diverge, it would be wise to keep a close eye on Greece, where despite the market believing the worst is over, things could yet take a turn for the worse. Last week, the New York Times reported that Portugal is not recovering, despite having done everything the European Union and the IMF asked. The 78 billion euro payout last May also did not help. Instead, Portugal is sinking deeper. When it received the bailout, Portugal's debt/GDP ratio was 107 per cent. It has since grown to an estimated 118 per cent.

 Connect with Wisdom Capital:

Facebook

The reason for this is that Portugal's economy is shrinking faster than its debt. Apart from Greece, whose debt/GDP is 160 per cent, Spain and Italy are two other countries that could face the same problem as Portugal, despite adhering to the austerity/tax-raising measures prescribed by the EU and IMF. The problem is that without growth, reducing debt levels becomes almost impossible. It's likely to lead to even higher debts. This is because high unsustainable debt calls for a bailout, the bailors impose more austerity as a precondition to loosening their purse strings, then the austerity causes slower growth, which then accentuates the debt problem. Those who advocate austerity hope that cutting public expenditure will provide more room for more private investments, which are more productive. In this way, they think austerity may prove to be expansionary. Sceptics might - quite legitimately - argue that 'expansionary austerity' is an inherent contradiction in terms (much like 'airline food' or 'military intelligence') but semantics aside, it's difficult to see much improvement in Europe's finances over the next few months. This suggests there is plenty of scope for contrarians. Speaking of those who go against the flow, Bank of America-Merrill Lynch in its Feb 16 Global Economics Weekly said while everyone thinks the US economy is getting back on its feet, it thinks otherwise. 'While the consensus has shifted, we haven't,' said BOA-ML. 'We continue to argue that the recent improvement is due to a recovery from the oil and Japan shocks, but ultimately will be reversed by shocks in the second half this year. Moreover, in our view, recent news underscores, rather than undercuts, our forecast of a very weak second half.' Contrarians take note.