Three thoughts on the ongoing bear market bounce:
- Our note on “Bears Beware” on 12 February 2016 caught the low of MSCI Asia Pacific Index (MXAP) at 112.97.. We believe the current bear market bounce may be nearing its end as MXAP trades at its fair valuation of 14.0x P/E, near its 3-year mean P/E.
- The lessons from Japan in the 1990s warn investor not to overstay on bear market rallies.
- Europe remains worrisome with increasing headwinds to growth and inflation.
Three-year P/E chart of MXAP Index
- The bounce may be over
In our previous note – Bears Beware – on 12 February 2016, we highlight that the correction has overshot and we advise caution for market bears. Since then, MXAP has risen from the low of 112.97 to 126.73, a hefty 12.2% surge. The trigger for the market recovery includes recovery of oil prices and loose monetary policies by the central banks. MXAP now trades at 14.0x P/E, near its 3-year mean P/E. This appear fair as compared to its distress valuation of two standard deviation below its 3-year mean P/E only a month ago. Given less than appealing valuations, we believe that there appears limited market upside in the near term.
2. Lessons from Japan
When Japan was facing deflation in the 1990s, the market was engaged in large trading range with 20% equity rallies every year during the 1990s. Therefore, this calls for an investor to be nimble with a “buying on dips and selling on rallies” strategy in this deflationary environment. As macro concerns stabilise, the normalisation of valuation will be the cue for investor to gradually raise their cash and rotate to defensive sectors. In line with our earlier point, it will be prudent to minimise risk and not overstay on this bear-market rally.
3. Worrisome Europe
The macro concerns for Eurozone area remain challenging with increasing headwinds to growth and inflation. Last week, European Central Bank (ECB) President Draghi announced more unconventional monetary measures. The refinancing rates were lowered to zero (from 0.05%) and the deposit rate decreased further to negative territory to ‑0.40% (from -0.30%). The quantitative easing (QE) programme is now a EUR 1.7tn programme as it was expanded to EUR 80bn/month (from EUR 60bn/month). In addition, the QE purchases has further enlarged in scope with the inclusion of non-financial corporate bonds from June 2016. The Euro (EURUSD) rallied 1.62% despite the announcement of these measures. We believe the rally will be short-lived as the ongoing problem including potential Brexit fears and growing refugee crisis in Europe remain unresolved and will continue to be negative for the region.