Shaking the Foundation!

The downturn in the global economy is now at least 9-months old, measured from the S&P high of last October. The housing and mortgage crisis is far from over.

The oil price crisis started in August 2007, when the oil price was only $70 per barrel, half what it now is. The prices of other commodities, particularly corn soybeans and wheat, have moved with the price of oil. Equity markets behaved as though they were immune from the building recession as they always do. But that charade lasted until last October when the S&P 500 peaked.

Everyone would like to know how long and how deep the 2008 recession is going to be. There are always commentators and analysts who think that the end of a recession is about six months away. In 2007 there were many so-called experts who expected a recovery in the second half of 2008; that expectation has now shifted back into 2009. Now, they believe the recovery will start in the second half of next year and persist through 2010. Will they be right this time?

One thing is clear that this is not going to be a short and mild recession like that of 2001. So, the time has come to ignore the talking heads who keep calling a "bottom" that could be years away. U.S. stock investors are nowhere near the "point of recognition" or the mid-point of the dominant trend when participants see that trend for what it is.

On July 1, a survey of Japanese manufacturers showed that companies expect earnings to decline for the first time since the 2001 recession. A survey in China showed that manufacturing in that country last month expanded at its slowest pace in three years. According to Moody’s, the global issuer-weighted speculative-grade default rate rose to 1.98% in June with much of the rise continues to originate from the US.

What does this means for the KLCI?

The KLCI is down 22% YTD and combined with the current political drama, more earnings downgrade are likely. The larger declines in other markets are by no means the result of any improvement in sentiment in Malaysia.

We think 2008/09 consensus earnings growth is more at risk. Importantly, domestic multiples remain at stretched levels, and we think a multiple de-rating is required to price in what are now substantial political risks. The Wall of Worry with which equity markets have had to contend for most of their upward journey continues to hold firm.

Pak Lah’s announcement that he will retire early and hand over power to his deputy by mid-2010, is not likely to ease, instead will intensify the political uncertainty gripping the country since March general elections. Muhyiddin who was tipped as a number-two to Najib after Abdullah’s departure, opined that if the duration is that long the situation will not become more convincing. UMNO veteran Razaleigh Hamzah, also questioned the premier’s right to hand over the party’s leadership to Najib. Worse still that Abdullah’s predecessor Mahathir Mohamad predicted that Najib will never become prime minister.

Compounding the matter is that Najib and opposition figurehead Anwar Ibrahim are now gripped in a bitter political brawl, with both facing serious misconduct accusations. Bottom line – we do not foresee an early end to current political uncertainty that has hampered Malaysia’s financial markets.

Even if there is a change to current administration, what unites the opposition is a common wish to see the government of Prime Minister Abdullah Badawi end, but for widely differing reasons. What next – your guess is as a good as mine!