Market Outlook as at October 8, 2013

The whole world is waiting anxiously as the US government is playing Russian Roulette. Looking at the DJIA, we can see that a potential triple top formation in place. With the 50-day SMA line cutting below the 100-day SMA line yesterday, the stage is set for the US market to drop further. This drop, when it comes, will be more severe than what we saw in May 2012 or October-November 2012 (of about 8%). It may mirror the drop in August-September 2011 (of 15%).


Chart 1: DJIA's daily chart as at Oct 7, 2013 (Source: Stockcharts)

The impact of a sharp fall on Wall Street would be felt around the world. We can see from the Dow Jones World Stock Index chart below, that this index dropped from 270 to 210 during the 2011 US Debt Ceiling Crisis. I expect a similar decline if the US government shutdown materializes.


Chart 2: DJWCs daily chart as at Oct 7, 2013 (Source: Stockcharts)

Bursa Malaysia was also severely impact in July-September 2011. We can expect a similar decline again if the US government shutdown takes place.


Chart 3: FBMKLCI's weekly chart as at Oct 7, 2013 (Source: Quickcharts)

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Due to misconception or poor reporting, many people around the worls believe that the imminent US government shutdown is simply a fight to control the US government debt, which currently stands at US$17.6 trillion (here). That is far from the truth. The fight is purely an attempt by a group of fanatical Republicans lawmakers to weaken President Obama and to cause him to be a lame duck President one year after his convincing reelection. They are relying on the Second Liberty Bond Act of 1917-- which instituted a statutory debt limit for the US government-- to prevent the passage of a clean spending bill (similar to our Government Budget). What these Republican lawmakers (known as the Tea Party supporters) did was to attach a provision to the spending bill which calls for the repeal of the Affordable Care Act (or, the Obamacare). This revision to the spending bill is a strategy to defeat a law (the Obamacare) by simply defunding it (or not to fund it).

Many Democrats and legal experts are saying that the attempt by the Republicans to repeal an Act by simply defunding the Act would set a dangerous precedent which could make America ungovernable. Thus, President Obama has broad support to push back the offensive mounted by the Republicans.

However, the Republicans are well-funded and deeply-entrenched due to gerrymandering of their electoral boundaries by State Governments (controlled by Republicans). This gerrymandering resulted in many House of Representatives seats that are dominated by Republicans (mostly, whites). They are immune from challenges from the Democrats. Secured in their incumbency, these representatives dare to risk everything to bring down President Obama.

While the Republicans have certainly overplayed their hands -- with the US public opinion turning against them-- they are in no hurry to reverse course. Thus, America is now on a collision course. It is hard to imagine how sanity can return to the la-la land!!


Source: Financial Times

While we contemplate the danger of the US government shutdown and its impact on our equity portfolio, we must not be too complacent that this problem will not happen in our Parliamentary democracy. It is certainly true that in a Parliamentary democracy-- with the executive and legislative on the same side-- the danger that we may face is less of the tyranny of a minority but the tyranny of the majority.

While no system of government is perfect, all form of government will fall if we gamed the system too much. In Malaysia, we have our own problem of gerrymandering leading to over-representation by the rural population. This over-representation of rural population (mostly farmers) would lead to government policies that favor this small minority at the expenses of the larger majority. We have seen this in Japan & recently in Thailand where governments would bend backward to subsidize the farmers while heavily-taxing the importation of farm products. This leads to absurd situation like the mountain of rice in Thailand & to some extent, Japan as well as US$100 melons imported into Japan. We must learn from their mistakes and do our best to safeguard & improve our system of government.