The Business Times featured on Friday that FED is likely to begin tapering bond purchases by the next meeting on November 2-3. It would mean that as much as $15b PER MONTH would be shaved off from the system in the process called tapering. While it is not specifically mentioned, we can expect following the tapering would be a series of interest rate hikes. How aggressive the interest rate hikes would depend very much on the prevailing business environment at that time. In all, if everything goes as planned, it should take several years for the whole contraction cycle to complete.
It is unlikely that the FED is going to hike up the interest rate aggressively though. In all likelihood, it is going to be a calibrated and accommodative style like what it did between December 2015 and December 2018. Unfortunately (or maybe fortunately) before the interest rate hike started to gain traction, FED had to back-pedal with three cuts of a total of 75 basis points in 2019. Then, came the COVID-19, when FED was forced to cut interest rate aggressively to near-zero once again. The whole episode of the ups and downs did not really hit our shore, except maybe, a small hike in bank deposit rate and then back to near-zero again. In all, if we look back into our interest rate history, we have enjoyed two decades of low-interest rate regime. This means those in the mid-forties or younger may not even have experienced the high prevailing interest rates as an income earner.
A market crash?
Interest rates hikes does not mean that a crash is imminent. It simply tells us that the market is getting red-hot, and the authority is stepping in to regulate it. Usually when the market hikes are carry out in a calibrated manner, it should go relatively smoothly, just like what we had seen in the last series of hikes between December 2015 and December 2018 for a total of nine interest rate hikes in US. There may be some knee-jerk reactions, but it normalised itself within a short time.
A market crash happens when some smart “alex” (or a BB you may call) try to outsmart the market by running for the exit door, causing others to follow suit and then the whole mass started to run out leading into a perfect storm that caused the stock market to crash. In fact, if we think about it, it could a deliberated action. The earlier one hits the exit door, the safer it is and the most profit that one can possibly rip. And when the market started to dive, it is time to be back in again to enjoy the next round of upside.
One common characteristics
Interestingly, whether crash or no crash, there is a common charateristics. Markets tend to be on a decline when high-risk assets, such as real estates and the stock market are on a high note.
Like what John Templeton once said, “Markets are born on pessimism, grow on skepticism and die on euphoria”. It is this cycle that happens again and again.
This observation may not be entirely without basis. When easy money is flowing into long-term risky assets, it means that the easier and low-lying fruits have been reaped. So, investors have to move on to the next level of risky assets. This goes on and ends in the real estate space. It is not an overnight event. It is gradual and it usually takes a few years to pan out. It is no longer a situation when we can simply plough extra cash into a high-yield stock and proudly show the dividends that we can earn from it. Here are the few news-worthy market declines that led to major crises:
- The Asian financial crisis
Property prices were running high in the early 90s. Everything was glamorous. Whether we were in Singapore, Malaysia, Thailand, Indonesia Philippines, Hong Kong or South Korea, we heard of mega-developmental projects going on. That’s was when the 5 tigers and 4 dragons terms were coined to signify the up-and-coming emerging Asian economies. The early 90s was extremely buoyant especially with the opening up of the CPF for investments. The property market was in a runaway fashion just like what is happening now. Apply your BTO flats today and it takes a few years down the road to complete. The curb on the Singapore property market was in May 1996. By mid-1997, the Asian financial crisis started, slowly at first before snowballing into a huge crisis in 1998/1999. The post-mortem examination of how the Asian financial crisis was funds were slowly moving back to US in search of higher interest rate, causing their respective currency rates to be under pressure. Previously, many emerging economies were pegged to the US dollars in fixed exchange rates regime, and most of these economies carry heavy US dollar denominated foreign debts. To preserve the exchange rate position, emerging economies had to dip into their reserves. Their reserves, unfortunately, were too small to move the needle. Once their reserves were depleted, they had to hike up the interest rates. The high exchange rate and the high cost of doing business, in effect, were preventing them from exporting their way to clear the financial mess. Even after a few rounds of currency devaluation, it was proven fruitless. In the end, most of the economies (except for Hong Kong) have to give up their currency peg to the US dollars and let their currencies go into a free fall.
- Global financial crisis
Bear Sterns collapsed in March 2008. It did not quite collapse the market even though financial stress was building up. It was until Lehman Brothers fell exactly six months later in mid-September 2008 that caused the market to be in a real turmoil. How did it happen? They have been heavily exposed to the Collateral Debt Obligations (CDOs), which were highly complex assortment of debt securities sold to simple-minded people. What was behind these CDOs were assets that were re-packaged and priced expensively before they are sold to ordinary people as an American dream. When people cannot pay up, investment banks got into trouble. More banks and financial institutions were later found to be involved as well because they underwrote these debts, resulting in a huge domino effect.
- Japan market crashed in 1989
The Japanese stockmarket tanked when the authority upped the interest rates aggressively in an effort to stem the asset bubble. To date, Japan has lost three decades of growth. Troubles came after troubles, including the natural ones like Kobe and Fukushima earthquakes. Even by today, the Japanese stock market has not reclaimed the level of 38,000 made in 1989. How did it happen in the first place? Huge asset bubble. There were even sources saying that grandsons of today are still paying mortgages for housing loans incurred by their grandparents. If we put this scenario in Singapore context, it it like paying expensive mortgage continuously for a 99-year leasehold property without any breathing period in between, and then returning the property back to the developer after the lease. It is no difference from renting an expensive property. The Japanese government has pumped many rounds of liquidity in the past with no significant effect. By today, it is the most indebted government among the advanced economies.
- Property market in China
Surely one cannot miss this. The real estate trouble has already been brewing for a few years by now. At the point of writing Evergrande has been trying all ways and means to dislodge itself from a pile of debts that is as big as the GDP of Singapore, more than US$300b debts. One may argue that it is the three red lines imposed by the Chinese authority that got Evergrande into this huge financial mess. But, the reality is that companies cannot be relying on debts to grow. It was exactly that they were in too much debts that caused the authority to step in. In fact, Evergrande was not the only one. Fantasia Holdings has just also missed its debt payment of US$205m payment on 4 October 2021. In a separate case, City Development has to write off its investments in Sincere Holdings and sold it for the price of US$1 after having invested heavily in the company. Overall, it is not exactly known the impact if Evergrande were to collapse and the repercussion on the property sector. The property sector takes up about 30% of China economy. It is not likely to be a passing collapse if it happens.
Certainly, there were more. Major crises often happened due to too much liquidity flowing into real estates. Whether in Singapore, US, Australia, UK, we hear of runaway prices in properties. So far, South Korea and New Zealand have increased their interest rate. It is likely that once US started to increase the interest rate in 2022, Singapore will follow suit a few months later. Let’s see how things pan out in the next few months. Again, I am not saying that all interest rate hikes will lead to a market crash. But it can set up an ideal condition for one to happen, especially when liquidity evaporates.
Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.