Treasure hunt

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Treasure hunt
Investors can make a fortune out of the financial crisis,
writes Eddy Wong

T
          he financial crisis has continued           waiting for signs of recovery. Even                   dragged down their price-to-book ratio.
          to shake global markets. Huge               the most experienced economists                           When earnings are negative, PB
          write-downs have contracted                 or analysts are unable to tell if the                 ratio works better than price earnings
the balance sheets of financial                       market has hit the bottom.                            ratio in helping analysts evaluate
heavyweights in the U.S. and Europe,                       Long-term investors, however, need               financial and property stocks.
and the global economy looks certain                  not despair. The golden rule is to invest                 A PB ratio of 1.0X means the
to slip into recession. Although U.S.                 when valuations are cheap. According                  share price equals the total worth of a
President George W. Bush signed into                  to a EuroFinance survey, 80 percent                   company if it sells all its assets. Take
law the US$700 billion bailout package,               of business professionals feel there is               banks as an example. In their business
the market reacted negatively, with the               a buying opportunity in the current                   models, most banks’ assets are loans
Dow Jones Index closing below 10,000                  financial crisis.                                     made to borrowers. Because loans are
points on 6 October, the first time in                     Financial sector funds and U.S.                  rarely valued above their historical
four years.                                           high yield bond funds have emerged as                 costs, the PB ratio of banks would be a
    As more negative news is expected                 very attractive investments after a panic             better valuation measure than their PE
in the months to come, most investors                 sell-off of financial stocks by investors             ratio, which would have been adversely
are staying on the sidelines and                      in recent weeks sank share prices, which              affected by the massive write-downs.

Chart 1: Price-to-book ratio dropped below 1.0X (as of 15 October 2008)

                                                      Average o r U S for a n financial companies
                                            A v e ra g e P B f PB ratio F inU.S.c i a l
  4.5
  4.5

  4.0
  4.0

  3.5
  3.5

  3.0
  3.0

  2.5
  2.5

  2.0
  2.0

  1.5
  1.5

  1.0
  1.0

  0.5
  0.5

  0.0
  0.0
      Oct-90        Oct-92         Oct-94         Oct-96        Oct-98         Oct-00        Oct-02         Oct-04        Oct-06         Oct-08
              Mar-90 Mar-91 Mar-92 Mar-93 Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08
Source: Bloomberg and iFAST compilation


                                                                                                                                       November 2008   +   A Plus [ 47 ]
                      1.5

                      1.0


       Investment
             0.5

                      0.0

                               Mar-90 Mar-91 Mar-92 Mar-93 Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08




      Chart 2: Yield spread widens

                            T h e Y i e ld S p r e a d b e t w e e n 1 0 - Y e a r U S H ig h Y ie l d B o n d a n d
                                                 The yield spread between 10-year U.S. high yield bond
                                                             and 10-year T r e a s u ry B o n d
                                                           1 0 - Y e a r U S U.S. treasury bond
        700
         700

         600
        600

         500
        500

         400
        400

         300
        300
         200
        200
          100
        100
          0
                0
                              Oct-97Oct-98
                      Oct-96Oct-97
                    Oct-96            Oct-98 Oct-99 Oct-00Oct-01
                                            Oct-99 Oct-00           Oct-02 Oct-03 Oct-04Oct-05
                                                            Oct-01Oct-02  Oct-03 Oct-04   Oct-05 Oct-06Oct-07 Oct-08
                                                                                                Oct-06   Oct-07 Oct-08
      Sources: Bloomberg and iFAST compilation


          The current PB ratio of U.S.                          grade bonds, also known as speculative               lower than its 2002 level.
      financials (see chart 1) has nearly                       grade and junk bonds, and we will                         U.S. high yield bonds are attractive
      dropped to its 1990s level, when the U.S.                 focus on corporate bonds here.                       both because of their potential capital
      economy fell into a recession following                       High yield bonds are usually rated               gains when the spread narrows and their
      the savings and loans crisis. The ratio,                  BB or below by credit rating agencies,               higher coupon rate. For example, a U.S.
      standing at about 0.98X as of 15 October                  which assign ratings based on issuers’               high yield bond fund can distribute cash
      2008, is much lower than the 18-year                      financial strength and credit fundamentals.          dividend of an annualized monthly yield
      average of about 2.2X.                                        The spreads between U.S. high yield              ranging from 5 percent to 9 percent
          Investors should note that more                       bonds and U.S. treasury bonds is the                 between 2003 and October 2008.
      write-downs will lead to a drop in the                    proxy that we use to determine how                        In fact, the cash dividend paid per
      book value and an increase in the PB                      attractive high yield bonds are. If the              unit of these funds is relatively stable
      ratio. The total write-downs by financial                 spread is narrow, the corporate debt                 and can provide regular and stable
      institutions across the world amounted                    default rate is low.                                 income for investors.
      to US$646.4 billion as of 15 October                          Chart 2 shows the yield spread                        The ultimate goal for all investors
      2008. Although the write-downs may                        widened to a historic high on 15                     is to buy low and sell high. Investing
      increase in the coming months, we                         October 2008, approaching its level                  during a crisis can benefit long-term
      believe the value of write-downs has                      in 2002. At the time, global non-                    investors with an investment horizon of
      reached its peak (US$168.1 billion) in                    investment grade bonds had a default                 three to five years.
      the first quarter this year.                              rate of 21.28 percent. Moody’s,
                                                                however, forecast that the default rate                Eddy Wong is a senior research
      High yield bonds                                          by the end of the year will stand at                   analyst of Fundsupermart.com.
      High yield bonds refer to non-investment                  around 5.7 percent only – still much

[ 48 ] A Plus   +   November 2008

				
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