Commentary by IPP Investment Division
14 Oct 2008

Financial Markets

The world’s financial markets went on a wild roller-coaster ride over the past 2 weeks. With the concerted efforts displayed by G7 and European leaders, we are optimistic that this coordinated approach is likely to provide stability to the present extremely volatile market.

Deleveraging will reduce global liquidity considerably and the global economy is likely to slow. The global economy will need time to work out the excesses but will emerge stronger in the recovery process.

Asia ex-Japan & Emerging Markets
•Present valuation of Asia-ex Japan and emerging markets continues to look attractive. With the likely slowdown in global economic growth, we expect growth in Asia ex-Japan and emerging economies also to slow but still grow at a higher rate as compared to the developed economies.
•We continue to favor and over-weight Asia ex-Japan and emerging markets. We hold our views that investing into Asia Ex-Japan and emerging markets is likely to provide better potential returns when financial market recovers, as Asia ex- Japan and emerging markets remains the world’s growth engines.

US & Europe
•While the financial markets went into a tailspin over the past week, the governments around the world acted swiftly and took concerted actions to “calm” the markets. G7 has pledged “no more Lehman-type failures” in an attempt to restore confidence in the market.
•While the concerted efforts by US and European governments are likely to help stabilise the financial markets in US and Europe in the short-term, we do not see this as a quick fix to the present financial crisis. Nonetheless, it is a very encouraging start.
•Deleveraging will take some time and US/UK/Europe economies will need time to work out the excesses. Liquidity will not be as plentiful as in the past and economic growth is likely to stall during the early phase of the recovery process.
•Hence, we do not see an end to the present problems in US/UK/Europe in the short-term and will continue to underweight them.

Commodities
•Commodities will still remain volatile going forward. However, the demand for commodities will be there as long as the emerging markets continue with strong internal consumption demand. The mid- to long-term trend in commodities prices is still positive.
•We think that an allocation to commodities is important to the portfolio as commodities generally provide a hedging mechanism to inflation, which will better manage volatility in a diversified portfolio.

Australian Dollar Denominated Fund
The Australian dollar weakened suddenly and sharply over the past 2 weeks. The primary cause is the unwinding of yen-carry trade. When the RBA cut interest rate on 7 Oct, yen-carry traders had to reverse their positions, selling Australian dollar which now has a lowered yield at 6%. The selling pressure weakened the currency.
For clients who have invested in funds denominated in Australian dollar, we think staying invested is appropriate at this current juncture.

Position For Recovery
•In current market environment, we see opportunities for the medium to long term investors in these investment themes: Asia, commodities, Middle East & North Africa and BRIC that have sound fundamentals and are poised to recover quicker and stronger in the future.
•It is probable for markets to see sharp rebounds as investors cheer over the initial coordinated efforts of governments and central banks. However, the initial euphoria could dissipate as the real economy works out the impact of the initial financial markets fall out. We must expect volatility.
•For equity investments, we reckon that this is not a good time to cash out as markets have fallen drastically. For clients who have longer-term investment horizon, we believe this is good time to accumulate more units through RSP.
•For fixed income investments, focus on those with shorter duration. For clients that are jittery and are looking for absolute safety, consider switching back to cash/CPF and start a 24-month RSP programme to invest in equities.
•For clients who are losing sleep due to the volatile markets, consider shifting to safer investments such as money market funds or switch back to cash/ CPF and start a 24-month RSP programme.
•Own a diversified portfolio. This is not the time to take concentrated bets on specific investments or sectors as recovery in financial markets is unlikely to be immediate.

This Investment Commentary is intended for general circulation only and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Opinions expressed in this commentary are subject to change without notice, and no part of this publication is to be construed as an offer to buy or sell any securities or financial instruments whether referred to herein or otherwise. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. We will not accept any liabilities whatsoever whether direct or indirect that may arise from the use of information in this publication. The company, its directors, connected persons or employees may from time to time have interest in the securities mentioned in this publication. Past performance is not necessarily a good indicator for future returns. Please consult your IPP FAR for any intended implementation.

Asian indices plunged today, anywhere from over 3% (Australia, New Zealand) to 10% (Indonesia). As of 1615h, Singapore and Hong Kong sank by over 4% each. Despite the approval of the US$700b Troubled Asset Recovery Plan package (“TARP”, which I dub “Trashed Assets Rollover Plan”), market players sense that the US (and the world for that matter) needs to do a lot more than drip-feed to the Sick Man of the World.

The Fed may consider an aggressive rate cut (50bp?), ECB is also considering rate cuts, but those may not solve the problem of the current deleveraging. You could tell the level of distrust among banks by the sharp spikes in LIBOR spreads, in any currency, you name it. Tight credit conditions also affecting borrowers – businesses and individuals. From Elm Street to Wall Street to Main Street, Halloween 2007 could continue with the next sequel this year, and across to Europe.

The US Elections, on 4-Nov-2008, is just another month away. I hear (American, of course) opinions that try to talk up the US market for a rebound circa “Super Tuesday”. The situation in the US is still serious, so that bounce could be short-lived.

Last Friday, investment legend, Bill Miller, who runs Legg Mason Value Trust that has beaten S&P 500 for 15 years straight until the fund was humbled since 2006, repeatedly said that US equities are good value. To an audience of 500, Legg Mason emphasized market recovery. During a small group lunch last Friday, I told Bill that he may be too early with his call, given the on-going deleveraging. He countered that he was “too late to go defensive”. Legg Mason expects recovery within the year, or best case within 6 months. Keep your monthly RSP rolling.

Is the Oracle of Omaha a harbinger of recovery in equities? Warren Buffet is the only non–Arab-, non–Mandarin-speaking savior of two American icons. From his war chest of US$38b, the investment guru bought preferred shares of Goldman Sachs (US$5b) and GE (US$3b). Even Anthony Bolton, a top Fidelity fund manager, also invested his own money in equities. I expect another <15% more downside.

China could be one of the first equity markets to recover. Three stockbroking reports alluded to more (aggressive) rate cuts by Chinese government which could be equity-friendly. But the possible deluge of shares held under moratorium and tainted milk scandal could restrain market exuberance.

Several pundits expect up to one-third of the world’s10,000 hedge funds to collapse. Year-to-date, 350 shut down, against 563 in the whole of 2007. The stronger ones could be cannibalizing the weaker ones. Even if this is not the case, the more able ones stand to gain market share (and that goes for banks, too).

Some US$600b of the US$1.8t global fund under management sought safety in cash (US$100b in money market funds). Several private bankers have been advicing their high networth clients to switch to gold. Hedge fund strategies that continue to work well include managed futures and macro. Our hedge fund partners are still in good shape; we have been communicating with them more frequently these days. Best is to employ multi-strategy funds, with capital guaranteed notes providing peace of mind. Even in hedge funds, you should plan to invest in a diversified portfolio, if possible.

While paper redemption continues to pressure gold value (or some could be switching to physical?), ordinary folks have been gobbling the physical. The US ran out of Buffaloes, Eagles and Kruggerands. In Singapore, a local bank ran out of 1-ounce gold coins, although smaller coins/ wafers are still available. While fears of global recession pressures crude oil (US$90), the value of gold appears to be holding steady above US$800. As the US and Europe inject hundreds of billions of dollars & euros, fears of fiat money to feed the gold-buying frenzy. Buy physical gold, in tranches, for hedge against disaster, and not for making obscene returns. A bounce in equities could trounce gold value; buy another tranche.

And speaking of cash, even if you plan to overweight cash, then are your banks safe? Hong Kong almost suffered a run on one of its banks until an influential investor sang a comforting lullaby. Singapore government sang its tune, too. Diversify, diversify, diversify. Investment is not about seeing positive return in all your investment instruments each time you look at the statement. Market conditions are extreme this time, we need time to see a return of confidence in the market.

From the Investment Desk
Eddy Tan
Head, Analytics & Asset Allocation
IPP Financial Advisers Pte Ltd