Lowest Point?

RECENTLY, our stock market has been affected by a lot of negative news, like unsettling US subprime issues, the weak economic growth as well as high political risks. Many retailers have lost confidence in the market.

Yet there are some who are trying their best to predict the stock market bottom, hoping to catch stocks at the cheapest price.

It is always a tough job to predict the lowest point in any stock market cycles. It requires some understanding of business cycles, which can be interpreted as fluctuations in economic activity.

It can be made up of expansions and contractions in the overall economy.

A peak in the business cycle happens when the economy reaches its peak and starts to decline. A trough in the business cycle occurs when the economy touches its bottom and starts to recover.

This is the turning point of any business cycle. Normally, stock market at this stage will show a confirmed sign of market turnaround.

The movement of stock prices is highly influenced by the companies’ profits. From a macro view, there are three determinants for corporate profits - consumer spending, industrial production, and services and capital spending.

Among the three, the key determinant is consumer spending.

As a result of the hike in oil prices, a high inflation rate and the overall weak economic growth have caused some slowdown in consumer spending.

As the main driver of consumer spending is personal income, which is largely derived from wages and the salaries, high inflation rate has caused some consumers to hold back on their spending.

To companies, the weak consumer spending will lead to lower demand for their products and eventually build up in inventories.

Most companies may take measures to reduce inventories, first by reducing purchases. Some factories may start to slow down their production if they see demand is getting weaker and, if this continues, it will lead to excess capacity, which subsequently might lead to retrenchment.

The overall industrial production rate will slow down while the unemployment rate will go up higher.

If the situation continues to weaken, some manufacturers may hold back plant expansion programmes.

Some proposed mergers or acquisitions may be put aside as not many company owners want to take the risk of expanding their business during this situation.

The slowdown in capital spending will lead to a further decline in future corporate profits.

The stock market is sensitive to future corporate profits. As consumer spending is the main determinant in corporate profits, any weakening in consumer spending will cause a big sell-down in stock prices.

This explained why the market sentiment was weak whenever oil prices edged up higher.

Where are we now?

According to Joseph H. Ellis in his book Ahead of the Curve, there are four stages of economic downturn - Stage 1: The peak; Stage 2: A modest slowing; Stage 3: Intensifying worry; and Stage 4: The advent of recession.

Stage 1 is where consumer spending and real gross domestic product (GDP) are increasing at a strong pace whereas Stage 2 is where the growth rate of consumer spending and real GDP only shows a slight decline.

Given our present situation, we are in Stage 3 with a higher inflation rate, slower growth in consumer spending and real GDP.

At this stage, the market may tumble about 20% from the peak. Some economists begin to worry that there are some possibilities that the overall economy may drop into a recession.

We do not think we will enter Stage 4 even with further decline in consumer spending and higher unemployment rate. It is not necessary that every time when we are in Stage 3, it will surely be followed by Stage 4. There are periods when we may revert to Stage 2 from Stage 3.

The decline in oil prices recently has provided some relief. Even though some economists commented that the worst may not be over yet, lower oil prices will contribute to a lower inflation rate.

Even though at this juncture it is still very difficult to confirm the trend reversal, the recent drop in oil prices has definitely helped to improve the overall consumer sentiment.

Understanding business cycles will help us to understand better stock market cycles. We always believe that we need to know what causes the market movement, then hope for the best and prepare for the worst.

·Ooi Kok Hwa is an investment adviser licensed by Securities Commission and the managing partner of MRR Consulting.