Thursday, May 29, 2008

Some thoughts of the market

If you have read the Straits Times today, it is mentioned that UBS chief expects worst of crisis to be over. Banks are clearing up their balance sheets and “everything will be over” by 2 years.

How did he know?

I am not as optimistic as he is. (Obviously he has to be optimistic; his rice bowl is at stake.) A housing led crisis (2007-20??) is not quite the same from a stock bubble crisis (2000-2002 technology: Nasdaq lost 70%, S&P 500 lost 41%).

During the burst of a stock bubble, anyone who has invested in stocks will lose money if they cash out. Some might borrow on margin, while others, invest their life savings. For those who invested using borrowed funds, they may borrow up to 2 years’ salary. When the bubble burst, many became bankrupts and spent the next 5-10 years repaying the loans they took to participate in the bubble. However, the market subsequently rebounded. Between Oct 2002-Oct 2003, S&P 500 rebounded 19%, Asia ex Japan rebounded 35%. New highs (peak) were achieved late last year.

The FED cut interest rates to 1% during the 2001 recession. This encouraged majority of home buyers to purchased housing on maximum loan. The loan period was typically 20-30 years. Due to irresponsible lending of banks, many home owners borrowed more than 30 years of their salary in anticipation to make a quick buck on their investment. The stake here is at least 30 years of their future income. Some even went on to buy a 2nd or 3rd property. That’s staking 90 years of their future income!

Compared to the stock bubble where a stock speculator possibly staked at most 2 years of their salary into the market(unless they mortgaged their homes), it seems that a “home speculator” may never pick himself up due to excessive leverage and exorbitant sub-prime interest rates. The home speculator’s poor investment decision will cause his whole family to be in debt, as everyone will be tightening their belts to pay for the roof over their heads.

Will the burst of the housing bubble create larger and longer lasting damages compared to a stock bubble? What we can see now is that the credit crisis is spreading to car and credit card loans, lowering consumer confidence, increasing unemployment rate, forcing FED to cut interest rates to induce spending and fueling inflation. More problems are created before the original set of problems is solved.

Based on my above analysis, it seems highly probable that a housing bubble has a bigger and wider damage influence than a stock market crash.

Will the housing crisis eventually lead to the stock market crash?

That is everybody’s guess.

(I will write my personal insights on investing in a bear market to follow up on the above article.)

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