“Panic Buying” May Not Last Longer

“Panic Buying” May Not Last Longer

Bubble warnings, structural global imbalances, probable Chinese slowdown, rising global interest rates, soaring energy prices – nothing has been able to scuttle the party in the global equity markets these days.

However, the frenzy and the enthusiasm in the across the board rally can be attributed to “Panic Buying” than sound investing based on a robust set of fundaments. Panic Buying is when investors start purchasing a stock following a large, substantial price increase. It is driven by the fear of being "left out" of the "next bit thing."

Yesterday, in the Asian trades, the bets in the options market against the Standard & Poor's 500 Index exceeded wagers it will rise by a 2-to-1 margin for a month, the longest since Bloomberg began compiling the data in 1995. That's seen as a warning sign the market is due for a decline of 5 to 10 percent after the S&P 500 rose to two records last week, say managers of almost $1 trillion at Morgan Stanley Global Wealth Management, National City Private Client Group and Russell Investment Group.

The Bank for International Settlements issued a warning in the first week of July that the Federal Reserve’s monetary policies have created an enormous equity bubble, which could lead to another “Great Depression”. The BIS--the ultimate bank of central bankers--pointed to a confluence of worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.

The movement in the US markets in the last two sessions of the previous week was baffling. The DJIA rose to all time high levels on the day the US Trade deficit for May rose to $60.04 billion, 2.3 percent more than in April and continued to witness follow up buying in the next session, with the US retail sales declining by 0.9% last month - the biggest fall since August 2005.

Given these economic numbers and the sheer pace of the acceleration in the global equity markets, the scorching rally seen in the last week is likely to top out very soon. The Shanghai composite is clearly overbought with more than 60% gain in the current year and the inflationary pressures continued to linger around the Chinese economy. China's National Bureau of Statistics said this week that it revised its reading for 2006 GDP to 21.09 trillion Yuan, bringing GDP growth for the year to 11.1 percent, compared with the initial report of 10.7 pct.

Meanwhile, global growth accelerated for five straight years to 5.4% in 2006, the highest in at least 27 years, according to the International Monetary Fund. That's despite oil prices doubling over that time. Clearly, while it demonstrates that the ability of the global economy to absorb the oil shocks has improved drastically over the last five years, the risks are inherent at a time when the balance of global economic power is shifting from the US to new age economies like China, India and other emerging markets like Latin America and Russia. Statistics due this week are expected to show that China is on track this year to pass Germany as the world's third-biggest national economy, behind the U.S. and Japan, in another indication of the rapid change of the global balance of power.

Goldman Sachs have also made note of this in one of their latest research updates. The investment back has said “China needs to take 'decisive' action on the monetary front to prevent the economy from overheating, even though the recent upward GDP revision for 2006 may cloud the picture somewhat because of the higher base to compare latest quarterly data with”. Sachs have further noted that “'Therefore, we maintain our view that monetary policy needs to be tightened decisively in the near term to prevent the economy from becoming overheated”.

Since the last two years, when the rally in the global markets intensified, most of the global markets have turned into asset classes, with sentiments driving the market forces significantly than the underlying fundamentals. The fact that the global equity markets are zooming to new highs just at the same time when the crude oil is witnessing a surge towards its all time peak of $78 strengthens this argument. Coming weeks should witness a moderate correction in the global equity markets as the technical funds look to flex their muscles to lock in gains after an extended rally in most of the asset classes. Chronic US sub prime-mortgage woes may spook investors further as housing cracks open up wider dents in the broad economy.

U.S. Treasuries are already pricing this as investors seek a haven for their funds. The 30-year bond yields broke through a 7 year high in the beginning of June and is now holding above where it gapped up at that time. Soaring yields for long-term bonds in turn means higher interest rates, which translates into higher payments for consumers and a drain on discretionary income that can't be put into new purchases to keep the economy growing at the pace needed.