Missing the rally
The extent of gains in the equity markets in the past few months have taken investors both institutional and retail by surprise says a new strategic report from Kuwait Financial Centre “Markaz”. The authors M.R.Raghu and Amrith Mukkamala feel that in majority of the cases, investors were on high cash levels in the period between Jan – Mar 2009 and this would lead to missing the strong rally between April – May. The steep rebound in equity markets, especially in case of India and Emerging markets has resulted in recovering almost 75% of the losses recorded in the movement from their peaks to trough levels. The Indian markets witnessed a decline from their peak of 20687 in Jan 2008 to 8160 in Mar 2009. Post this the index has witnessed an appreciation of 72% within a matter of 2.5 months.
However, there are the other markets which are still to make their mark in this rally. For example UAE has witnessed a 70% drop since its previous peak to trough has climbed by only 15%, thereby underperforming significantly. Similarly, Kuwait, which posted a peak at 15,655 in Jun 2008 witnessed a trough in Mar 2009 at 6392, a decline of 59%. Post this, the index has witnessed a reversal of only 21%. The authors state that the questions that are begging answers by fund managers and retail investors alike currently are: Is this a new secular bull market? and, are we to buy now, having missed the rally so far? The authors point out that the answer is selectively, yes. The report overweight’s UAE, Neutral on the rest of the markets in the focus list ex-EM and India.
The report states that the attractiveness of the current rally and its sustainability on a near to medium term basis can be ascertained by looking back into the history. The report ascertains the market attractiveness using a combination of four main factors: 1. Risk, 2. Extent of damage (Underwater perspective), 3. Scale & 4.Speed.1. Risk – Lower across the board (Weight: 25%)
The risk levels across all the markets have witnessed a decline since the peak volatility levels witnessed during the Lehman collapse. The yard stick to choose the volatility levels during the collapse of the Leman brothers is to gauge the perception of investors. Investors perception during the collapse of Lehman Brothers was ripe with speculation on which institution will follow suit next and the magnitude of systemic defaults that might take place. The decline in volatility levels from this yard stick showcases that these risks have witnessed a decline. The Ted spread on a broader basis has also returned to levels seen before the Lehman collapse. The CBOE Vix index is down nearly 20% for the year. On a macro basis, the authors believe that declining risk levels in the markets are positive. The report uses an in-house proprietary risk model (Markaz Volatility Index (MVX)) to measure and assess the risk levels across various markets. (visit www.markaz.com/research to read about the methodology and to see the individual market & risk graphs)
The emerging markets, UAE and S&P 500 have witnessed the highest fall in volatility levels compared to the levels during Lehman’s collapse. MSCI EM index recorded its peak MVX level on 30 October 2008 at 10,242 and the current MVX level at 3,418 signifies a decline of 67%. Due to the inverse relationship of MVX and the underlying index, the index posted a trough at 454 on 28 October 2008 and is currently at 756, a gain of 66%.
Saudi Arabia and India have posted least decline among the markets used for comparison. Saudi Arabia has posted a decline of 55% from its peak on 14 October 2008. However, for Saudi Arabia, the peak in MVX during Sep – Dec 08 period at 11,386 is not a life time high peak. Saudi Arabian MVX peaked out in May 2006 at 13,578.
Among the markets the ranking favors markets with a fall greater than 60% in their MVX levels. Post this, the rank is reduced for all the markets with a fall between 50 – 60% in MVX Levels.2. Underwater perspective – Saudi Arabia looks attractive (Weight: 25%)
The underwater perspective provides a measure of the extent of damage that has occurred at an index level and its comparison to the previous down turns in the equity markets. The measure also provides the extent of run up required to breach the previous peak. The higher the damage and higher the distance that need to be traveled to reach the surface, (previous peak) is considered more attractive. A quick run up from the trough levels and lower distance to previous peak is considered unattractive taking the current economic back drop into consideration.
All the markets posted negative returns in 2008. In this, some of the markets have posted a trough in late 2008 or in early 2009. Post this trough some of the markets have witnessed strong rallies, which has resulted in wiping out almost 3/4th of the losses witnessed since the peaks!. This is in spite of the fact that most of the economic forecasts have not witnessed such a level of upward revision. Among the markets used for comparison, India has witnessed the highest run up post the trough index (Sensex) level of 8,160 posted on 9 March 2009. Within a span of 2.5 months, the Indian benchmark index has recorded gains of 72% from its trough to the current level of 14,150. The Indian markets are closest to the surface with an underwater level of $67, thereby requiring another 48% to reach the surface.3. Speed – All markets are positive (Weight: 25%)
Speed comprises of two measures : 1. Peak to trough duration and 2. trough to peak duration. The latter measures the speed at which the markets have climbed back to peak levels from their trough levels and compares it to the duration of the recent run up. The higher the similarity between the durations the lower the possibility of further run up. The authors state that they would prefer a higher duration taking into consideration the one off economic event we are in currently. The first parameter measures the historic durations of the fall from the peak to trough values and compares it the duration of the recent peak to trough movement. Higher the current duration as compared to historic durations provide to lower possibilities of further fall in the markets.
The time duration of the downtrend journey from the peak to trough has been severe than the previous down trends for majority of the markets. There are very few exceptions. Kuwait has witnessed more severe downturns which lasted for 17 months on an average in the past as compared to the current one which had lasted only for 9 months. The current downturn started in June 2008 and ended in March 2009. The most severe down turn in Kuwait was witnessed in Oct 1997 to Jan 2001, a 39 month decline to the trough value.
Another complementing parameter that is used to evaluate speed is the duration from the trough to peak. On a whole, the authors note that the current movement from the trough values to be at its infancy stages. The previous cycles have been far more elongated. Majority of the markets are currently in their 2nd and 3rd month from their trough. S&P 500 has historically witnessed an average trough to peak period of 38 months. The current run up is just 2 month old. The last trough in S&P 500 was seen in Oct 2002 and the upward journey from that point lasted till Oct 2007. Similarly, Kuwait has also witnessed longer bull market cycles averaging at 26 months.
The report rates all the markets as positive on this parameter. The authors believe that the current run up is in its infancy stages over a longer term perspective. For UAE, the gap between the historic average and the current move is too low due to the prolonged bear market. UAE posted a peak in Nov 2005, post this the markets have been in a bear market till Feb 2009. Due to this, the UAE markets have only witnessed one bull market rally from July 2005 till Nov 2005.4. Scale – India & Emerging markets look overbought (Weight: 25%)
Over a short to medium term outlook, the authors believe that some of the markets are over heated as the current rally has been stronger than any previous rally. The authors state that from a macro economic perspective, the current global recession is still looking better than just only the great depression. Therefore, the report favors those markets which have seen lesser price appreciation as compared to the previous downturns.
India stands out very clearly as the market which has witnessed the highest average monthly return in the current trough to peak period. In a span of 2.5 months from the trough the benchmark index has gained 72%. This results in average gain per month of 36%!. While the historical average of such gains for similar period has been 9%. Similarly, S&P 500 has also had gains which are higher than its historic averages. The historic average monthly gain from trough to peak for S&P 500 has been at 3%, whereas the current gains are at 17%. However, for China, the current gains are far lower than historic gains. The current monthly average gain at 9% is far lower than historic average at 24%.
Since the current run up in rally is just 2-3 months for most of the markets, the report compares the trough to peak returns for markets during their first 2-3 months of bull rally. The authors note that this comparison provides a better like to like comparison of the period immediately after markets post a trough. Even in such a comparison, Indian markets continue to look stretched at the current levels. The ranking favors markets which have witnessed lesser returns as compared to historical averages. UAE, China and Kuwait are rated high on the basis of speed. India, EM, S&P 500 and Qatar are rated low.Investment Conclusion – Overweight UAE, Underweight India & EM
Taking the various rankings and using the weights the investment themes are constructed. The reports states that some of the markets look overheated from a short to medium term perspective. The report recommends an underweight on both the Emerging market basket and India. The authors state that both these markets are currently stretched. UAE is rates as the only over weight as the correction in the markets had been steep and there has been a very marginal recovery from the trough levels, thereby providing a possibility of further gains with limited downside. Rest of the markets are rated as neutral.# End #
Kuwait Financial Centre 'Markaz', with total assets under management of over K.D 781 million as of March 31, 2009, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was recently awarded a BBB+ corporate rating by Capital Intelligence Ltd.