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Goh Eng Yeow

The Straits Times

Publication Date : 21-01-2013

Three weeks to go before the curtains descend on the Year of the Black Water Dragon and grateful investors have plenty of reasons to raise a toast.

The year has defied the odds and turned out to be a bountiful period, thanks to the Dragon chasing away dark tidings like the euro zone crisis and a bitterly contested presidential election in the United States.

Investors have been able to rebuild their wealth after the stomach-churning market swings riding the Tiger in 2010, and then being forced to hide in a hutch like a Rabbit the following year, as one bad piece of news after another roiled stock prices.

How the mood has changed.

Last week, more than half of the respondents in the Bank of America Merrill Lynch's fund manager survey said they are bullish on equities, while 75 per cent of the respondents in a HSBC survey tracking investor sentiment are just as exuberant.

There is a sea of calm in the world's financial markets as far as the eye can see. The Vix Index of Wall Street - tracking the swings registered by the 500 largest US stocks - reflects the new mood and is now at its lowest level since June 2007, the month before the US sub-prime crisis flared up.

Fund tracker EPFR said US$7.2 billion flowed into all equity funds last week, with about US$2 billion going to Asian funds and US$2.2 billion to North American ones. It was the 19th consecutive week of inflow to regional equity funds.

There is even a dash for trash. Penny stocks from New York to Singapore are rallying hard while demand for US junk bonds - the debt issued by financially weak companies - is so high that yields have fallen to mid-2007 levels.

Still, investors have to thank central bankers for the Dragon Year's bounty.

European Central Bank (ECB) boss Mario Draghi started the ball rolling at the end of July when he promised to save the euro from breaking up.

"The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough," he said, as he flagged to the world's short-sellers not to carry on attacking the euro.

It was followed two months later by another round of quantitative easing by the US central bank, as it tried to stimulate the US job market.

China did its part, promising one trillion yuan (US$159 billion) of fresh infrastructure spending, even as its mighty industrial sector roared back into hyper-drive, while Japan acted to weaken its currency to try to stimulate its moribund economy.

Even the Basel Committee on Banking Supervision, which determines global regulatory standards, lent a hand by allowing lenders until 2019 - four years later than expected - to comply with new rules requiring them to stockpile enough easy-to-sell assets to survive a crisis for 30 days.

Yet there are worries that such a potent brew concocted by the central banks may turn out to be toxic for the financial system.

As US markets writer Jim Jubak noted, even in normal times, creating that much money would have raised the value of financial assets as some would have flowed into stocks, bonds and real estate.

"But these haven't been normal times. With companies often reluctant to invest and banks often reluctant to lend, a larger- than-usual portion of this created money has flowed into financial assets. Central banks have provided considerable fuel for a bull market," he wrote.

And therein lies the rub. What happens if central bankers take away the punch bowl just as the party goes into full swing?

Stocks are not overvalued at current levels but are also not cheap. For example, the Straits Times Index is still about 20 per cent short of its 2007 record high of 3,857.25, but it is up about 20 per cent in the past 12 months.

Jubak noted that one factor that may continue to underpin the stock market rally would be the continued recovery in China and the boost this would give to the region, even if the recovery in Europe and the US falters.

The other issue is how central banks can start shrinking their bloated balance sheets - a necessity to keep the faith of the markets - without throwing the global financial system into fresh turmoil.

That must surely be the biggest question investors must grapple with, even as they rub their hands with glee and look forward to the Year of the Water Snake.