Market Outlook as at September 28, 2011

Global equity markets have dropped quite significantly over the past 2 months. The decline was driven by many factors but to my mind, the most important factor is the festering sovereign debts problem in Europe. This problem is so intractable & complicated that the whole world is worried that it could trigger the second Global Financial Crisis. The first one was triggered by sub-prime crisis in the U.S.

With central banks everywhere running low on ammunition, another Global Financial Crisis could tip the world into Depression II. However, there are signs that the European Union is now putting the finishing touches to a massive rescue plan, which would allow for an orderly default by Greece and possibly another two peripheral countries (Portugal & Ireland); set in place a fire break to prevent contagion effect to other Club Med countries (Italy & Spain); & recapitalization of Euro banks which are expected to take massive haircut on theirs exposure to these peripheral countries.

At this moment, the details on these proposals are very scarce. No official details have been announced. As the plan was supposedly presented by U.S. Treasury Secretary Geithner recently, it is expected to borrow heavily from the U.S. initial rescue package in 2008 [known as TARF]. But the big question remained: Who is going to foot the bill? Everybody assumes that Germany has to be the fall guy. Why? And, would the Germans agree? It would be political suicide for Merkel to cause Germany to take on the entire burden alone.

Meanwhile we saw a huge rebound in risk assets (as equities & commodities) and a sharp correction in safe assets (such as gold & USD). Is this reversal justifiable in the absence of any detail of the rescue package as well as the formidable obstacles which need to be overcome? To my mind, there are too many questions left unanswered at this moment to warrant a sharp recovery.

As for our market, I believe that the current rebound could develop into a bear rally, with the potential to test the 80-week SMA line which was broken in mid-September. I regret to say that this is just an unscientific guess based on my study of the bear rally for 2008. As noted in the previous post, FBMKLCI struggled to hold above the 40-week SMA line in January to February 2008. In early March 2008, it broke below this important support & panic selling ensued. The index dropped slightly below the 80-week (note: 2 X 40-week) SMA line & then snapped back to the the 40-week SMA line.

This round, we saw panic selling once the index broke the 1400 psychological level as well as the 80-week SMA line (in the late September). The expected panic selling set in and the index dropped below the 160-week (note: 2 X 80-week) SMA line. I've expected a rebound after the breakdown of the 160-week SMA line. If we can see a similar bear rally like 2008, the index could potentially test the 80-week SMA line which lent support to the market earlier. Where would the 80-week SMA line be over the next few weeks? It would probably be in the vicinity of 1410-1430.

If you choose to trade or invest in this market, you have to accept the risk that the reported rescue package will pan out to the market satisfaction. In my opinion, we are in a very risky situation as the market has rebounded too sharply in anticipation of this good news. A skittish market does not take disappointment well.


Chart: FBMKLCI's weekly chart as at September 27, 2011 (Source: Quickcharts)