My Diary 558 --- The Potential Market Correction

Market Thoughts -- The Potential Market Correction

On Monday and Tuesday, the argument on my market note for the potential market correction is based on the perspective of market positioning. I thought we are going to see a 10% correction this week. Looking forward, I still think the 10% correction is highly possible based on several risk factors down the road.

I. US Markets

Banking Sector

Ø One of the more tangible concerns which surfaced yesterday were press reports indicating that the Obama Administration is considering converting its preferred shares in the country's banks (injected via the TARP) into common equity. If that were to occur, it could effectively result in the "nationalization" of those banks.

Ø A sizeable government ownership of voting shares-and that prospect was quite poorly received by financial stocks in particular, and by equity markets more broadly.

Ø With that perception, combined with yet another potential "rule change" in the TARP program, will also likely deter private capital from reinvesting in the banking system,

Ø From a tactical perspective, note that the stress test results are due on May 4, and the weekend before could well prove to be another nail-biter for financial markets, as we have seen from the hot debates among the street, US Treasury and The Fed.

Technical and Valuation

Ø The MACD red/white line showed a downward cross since March 09. Certainly, tt's usually lagging indicator but pretty accurate.

Ø Earning and valuation wise, the current bottom-up “bear consensus” continues to move lower and is now $45.81. I think that make sense as if normalized EPS for SPX =$80, given financials usually contribute about 40%, so we will have $48 per share. In addition, the non-financials earning over the past few years do have certain amount of financial leverage components, that say conservatively 10%, then it is $5.

Ø That said, it is not too low to begin with EPS=$50 for SPX in 2009. Then, under two scenario: 1) deflation = 10XPE, then SPX = 500, or 2) 2) inflation =15XPE then SPX = 750. Today S&P500 = 850, equal to +15% downside.

II. Local Markets

Several market news and rumor are worth some concerns there:

Ø PBoC withdraw Rmb165bn of liquidity from the opening market, including Rmb100bn though 3months' REPO. It is actually 14-months high that central bank pull back money from market and suggests the government want s good control on the liquidity if it flooded.

Ø Market rumor has it the incremental loan from the 4 big banks is actually negative Rmb 90bn. Though April is not ended yet but many should start to be worried if the new loan party is over.

Ø A rumor from domestic market last night says that CSRC may issue a circular on new IPO issuance rule next week. IPO resumption is one of three key "STOP" signs (IPO/Credit tightening/inflation) as A-shares market move above 2500 and test new high at 2579 today and I think the chance for IPO resumption is rising significantly. In general, this poses a significant setback to investors' sentiment.

Ø In addition, Copper/Mining stocks 9JXC -7%, Western mining -10%) pulling back sharply, they were at the forefront of this extended market rally, when they pull back, it is likely to be quick and sharp, in turn hurt broader market sentiment.

Ø The street saw something unusual as domestic PE funds' strong holds, such as Guangzhou shipyard(600685, -7.685%)/Yimin Commerce(600824, -5.17%)/JiEng Nickel(600432, -7.94%), are all plunging very hardly.

Market Observation on April 20-21

For US market, I think --- 1) Technical wise, S&P has rallied 6 weeks, which is typically indicative of a market overdue for some consolidation; 2) Sentiment wise, the “dumb money” sentiment measures are back above the January high and suggesting an approaching top; 3) 1Q09 is the weakest quarter for US economy growth in almost 50 years; 4) Earning side, putting the trading results of US banks aside, we are almost certainly due for some disappointment as most of S&P 500 companies and Dow components report this week; 5) on last Friday, Citigroup (-9%) was a laggard even though it posted a BTE results and was a leader during the last weeks. Obviously, investors pushed back when the firm indicated a WTE outlook on 2Q09 charge offs and its credit costs.

For Local markets, I think 1) USD gets stronger again, indicating weaker Asia markets usually; 2) MSCI AxJ can not sustain 200DMAVG @ 325 WITH 1.5xpb; 3) HSBC was down 6%, which was a material part of recent stellar rise in Hangseng, and CM missed the street's expectation; 4) Commodities stock like CNOOC (-4.3%) is on the back foot with the plunge in Oils; 5) Liquidity wise, the upcoming (listing May 8th) Zhong Wang 1.58M USD IPO will drain money from the market, but my bigger Q is how much money has been sitting on the sidelines and waiting for such a pull-back? This will test whether the correction can be held somewhere around 14300.