Overvalued

It was murder at the stock exchange yesterday. Volumes were thin but the losses were large.

The collapse in stock prices was so substantial one veteran analyst thinks the bottom could be somewhere in the 5,600-point range. That is still some way to go from where the market stands at the moment.

That is certainly way away from the 10,000-point prediction President Aquino made for the Philippine market some months back. How Aquino could have arrived at such a prediction, no one really knows. Many things emanate from his mouth that boggle the mind.

Those who took the President’s prediction as gospel truth (or took it “literally,” as Sonny Coloma would say) are now wallowing in losses. Our market has dropped substantially from the 8,000-point level where the market was when Aquino made his puzzling prediction.

For most market analysts, the most proximate reason for the across-the-board drop among the Asian markets may be summed up in a word: China.

The latest information shows a significant weakening of China’s economy. Domestic consumption has not been robust enough to compensate for the gradual reduction of China’s exports. It will be a struggle for China to hit a six percent growth target for this year – as it will be for us, notwithstanding this is an election year.

China’s slowing growth will impact commodity prices. That means economies reliant on commodity production will be in for a rough ride. The drop in oil prices exemplifies this.

A vicious cycle then happens. Weaker commodity-exporting economies will consume less Chinese exports. Weaker Chinese exports means slower growth for the only economy with enough size and population density to drive global economic growth. She will not be playing the role of global growth driver for a while.

The Eurozone is still harried by debt problems. North America is expanding only marginally – and even that might be hobbled by interest rate increases. The massive drop in oil and gas prices handicaps Russia. The other large emerging economy, Brazil, is currently mired in debt and liquidity issues.

There is, at the moment, no reliable driver for global growth. That is the crisis of this time. The absence of a reliable growth driver diminishes certainty in the markets.

Many things stoked investor concerns about the Chinese market. Policies are not only reliable but also often erratic. Political considerations often imbue financial policies. The quality of China’s economic and financial statistics is generally poor – hardly sufficient for confident investment decisions.

Last week, as the Chinese market opened in the new year, the sentiment was negative. Twice last week, the so-called “circuit-breakers” (automatic halts to trading after losses exceed a certain volume) kicked in, forcing suspensions in trading. To deal with the volatility, Chinese authorities dispensed with the “circuit-breakers” altogether.

Then Chinese monetary authorities signaled more money will be plowed into the market to stabilize the situation. That might be (as in the quantitative expansion programs of the US and Europe after the 2008 meltdown) a viable response. In the present situation, however, that might not be the wisest approach.

The main problem with the Chinese stock market is that it is overvalued. Big corporations are selling stocks with P/E ratios as high as 61 percent (where 15 percent) is elsewhere considered prudent. Plowing money into the markets will not cure the overvaluation. That will only make things worse.

A high P/E ratio might be considered an acceptable gamble for investors for as long as growth prospects are unusually high. With the moderation of China’s growth rate, holding on to expensive stocks might be unwise.

In the more mature financial markets, the only reliable solution to overvaluation is a good shakeout. Allow the markets to correct. Take the hit and rebalance. Consolidate and move on.

China’s leaders have a psychological problem with that. They take market declines as an affront, a threat to their legitimacy. This is why they tend to throw in money when the markets show weakness. That is like giving a child a chocolate bar whenever he cries. The result is unhealthy obesity.

At some point, China’s leaders will come around to understanding modern financial markets cannot be centrally planned. Until they do, we will all have to bear with all the fumbling besetting China’s market.

Fortunately, China is a net lender to the world, not a net borrower. This means we will not likely see a financial meltdown such as the one that happened in 2008 and threatened to drag all of us into a depression.

Or so we hope.

To be sure, we will be in for a lot of market volatility as valuations are reimagined and prices stabilized. No one knows how long the volatility will last. Only Noynoy Aquino seems to have the ability, or the gall, to make long market predictions.

Some people love volatility. The smartest and most nimble investors can ride the fluctuations and make money from accurately anticipating price movements. For most others, this is a minefield where fortunes could be wiped out by the price fluctuations.

We do not know how deep the PSEi might sink given the general market turmoil we are experiencing. What is sure is that the price collapse makes for a dispirited business community.

The Ramos administration was hit by the Asian financial crisis of 1997. That had the effect of pulling the rug from under the “Philippines 2000” program of rapid economic expansion.

The Arroyo administration managed to counteract the effects of the 2008 global financial meltdown rather effectively, sparing our economy from recession. Nevertheless, it suffered negative political fallout from all the market uncertainty.

The Aquino administration, at its twilight, is again doomed by market forces beyond its control.