Inflation! Inflation! Inflation!

Over the past few weeks, geopolitical risks have heightened due to unrest in a few states in the Middle Easter & North Africa (MENA). This has resulted in a sharp drop in many stock markets which were weakened earlier by concern about inflation. With crude oil prices trading at or above USD100 per barrel, economists are worried that the nascent global economic recovery may be seriously harmed. See Chart 1 below.



Chart 1: Brent's daily chart as at Feb 25, 2011 (Source: WTRG)

How should we treat the geopolitical problem in the MENA states? Since 2008, investors have been buffeted by one catastrophe after another. First, we were hit by the near collapse of Wall Street due to the sub-prime problem. Next, we were hit by the sharp drop in the value of the Euro due to the financial crises among the PIIGS states (which are still unresolved). Finally, we are hit by the multiple collapse in North African states that is now threatening to spill over to the oil-exporting Middle East. Is this another buying opportunity, disguised as a near-death scenario or is this the real deal- the final straw that will break the camel's back? We won't know.

What we do know is that the market is technically very precarious. Let's list them down:
1) This bull run is approaching its 2nd anniversary- something that I have not seen in my 17 years in the Malaysian stock market.
2) FBM-KLCI may have broken below its long-term uptrend line while FBM-Emas is testing its uptrend line.
3) The FBM-KLCI dropped below its 30-week SMA line at 1477 today before recovering. FBM-Emas came very close to its 30-week SMA line at 10077. I would consider these levels as the last line of defense for the market.
4) Indicators, such as RSI & Williams' %R, are very bearish.



Chart 2: FBM-KLCI's weekly chart as at Feb 25, 2011 (Source: Quickcharts)



Chart 3: FBM-Emas's weekly chart as at Feb 25, 2011 (Source: Quickcharts)

Other things to note are the poor market action, such as the breakdown among the top blue chips such as CIMB & Genting. In addition, we may see consistently large number of losers in the market, even in days when FBM-KLCI was up or unchanged. The narrow breadth in the market is a sign of a topping out process.

Finally, we can see that inflation is getting from bad to worse in this country. This morning, we saw the headline "Professionals and top execs set for huge increments". Last week, it was "Legal fees hike driven by market forces, says Bar Council". How many more such headlines would we see before the Government would launch an all-out anti-inflation drive which may include raising interest rate or SRR aggressively? And, if you think you are having it bad, think about the lower income group whose wages can hardly match the inflation rate. To add insult to injury, they will suffer even more due to the withdrawal of subsidies across the board resulting in higher food prices as well as higher energy costs. [Note: The increased cost of living coupled with high unemployment rate were the main drivers that brought the Tunisians & the Egyptians to the streets. If my reading is correct, we won't see the same intensity in the crowd in Bahrain or any of the rich Gulf states because they are way too pampered to put their lives on the line. ]

Based on the above, we should remain under-weight the market. While buying opportunities may be present, we should exercise careful discretion & avoid over-exposure or over-trading.