Update on market commentary on the stock market collapse that began on 2 Aug 2011

This is an update to http://help-your-money.blogspot.com/2011/08/market-commentary-on-stock-market.html

I made a post on 14 Aug 2011 of my belief that a strong rally will come before the market collapses further due to the huge amounts of cash sitting on the sidelines, insider purchases and strong earnings despite the market rout. I acted on my belief and deserved the painful consequences. Based on recent market action, I have been proven wrong and suffered losses. From 12 Aug 2011 to 23 Sep 2011, the Straits Times Index has fallen more than 5%. This is the criteria which I use for being wrong. In investing, I regard losing money as equivalent to being wrong. No point in using excuses like "I am a long-term investor" (as if the stock will surely bounce back later), "The market is irrational" (as if everyone else is stupid except myself), "Short-term fluctuations do not bother me" (self-deception? Losses always hurt)

The global financial markets have grown too dependent on money-printing from central bankers like drug addicts. When QE1 (quantitative easing) neared its end around middle of 2010, global markets slumped like a drug addict as the drug effect wore off. Then, Bernanke administered a fresh dosage in QE2. Global markets rallied in September 2010. The drug effect wore off again after the middle of this year. Come QE3, also known as Operation Twist. Unfortunately, the drug dosage is not enough this time because the appetite of drug addicts grows with every dosage. The immediate negative market reaction is evident of this fact. The bullishness of the precious metals market is a measure of the amount of central bankers' money-printing activities. Look at how Gold and Silver crashed after Bernanke announced Operation Twist.

Operation Twist aims to lower the interest rates of long-term debt by selling short-term Treasury securities and buying the longer-term ones. What else can the Federal Reserve do? The short-term interest rates of US Treasury securities is already near-zero. How to lower the short-term rates further? This is why Bernanke could only work on longer-term interest rates this time. I am not quite sure how to interpret the market's reaction to Operation Twist. Should one interpret the recent market crash as the Fed not doing enough or the Fed has lost the ability to do anything to stimulate the economy? When short-term interest rates are near zero, monetary policy has clearly lost much of its power as an economic tool. Therefore, the US economy has to look towards fiscal policy for stimulation. The recent US debt-ceiling crisis shows that political bickering has paralysed fiscal policy. When one party says taxes are too bloody low and the opposing party says spending is too bloody high, stimulative fiscal policy is impossible because taxes cannot be cut and spending cannot be raised. Actually, the rich world does not have much room to stimulate the economy using fiscal policy given high government debt levels and persistent budget deficits. Austerity is the only way out. If austerity is chosen, the near-term prospects for financial markets will be terrible and uncertain in the longer-term. If fiscal austerity is abandoned in favour of the more political palatable monetary money-printing, then inflation will follow. In this scenario, the financial markets will do well even if fundamentals are poor. When you have too much money chasing too few assets, asset bubbles will be formed. Holding cash in such a situation will be disastrous. Seeing the American politicians in action during the debt-ceiling crisis point towards money-printing being the preferred option.

Indeed, Operation Twist may boost speculative activities, particularly in the property market, by reducing longer-term mortgage rates. Already, the loose monetary policy in the US is being exported to Asia and creating bubbles in our property market. In 2008, we had the US banking/real estate crisis. Come 2011 and 2012, we will suffer a full-blown European sovereign debt crisis. The nightmare scenario is that in 2014-2015, it may be Asia's turn to suffer a financial crisis when the property market bubble burst in China, Hong Kong and right here in Singapore.

There is an even darker nightmare. It is the social instability that persistent high inflation and unemployment will bring. This is chaotic and totally unpredictable. High inflation in China in the late 1980s created the conditions for the Tiananmen protests that led to the massacre. Hyperinflation in Germany gave us World War II because the German people voted Hitler into power out of anger.

Most of what I wrote will probably turn out to be empty worrying. It is a habit borne out of worrying about the downside before investing. By the way, I will still be buying stocks however pessimistic. As the macro-picture worsens, it is likely that even good stocks will go down further. However, the chance of permanent impairment (go down and never recover) is quite low when buying in times of recession/depression.