Market Update.

This weekly commentary was compiled by DBS Vickers this morning:

Stay cautious this week, as the market is likely to continue its downward bias. The play on recent IPO listings has waned while S-chips could suffer more downside amid concerns about margin pressures as investors unwind.

The impact of the credit crisis on the corporate earnings of US financial companies will be accessed. Expect financial companies to announce more losses stemming from their exposure to mortgage-related investments.

Citigroup releases results on Tuesday, JP Morgan Wednesday and Merrill Lynch on Thursday. The releases of December US PPI and CPI will also shed more light on inflationary pressures given the weakening USD.

Trading interest during the past 2 weeks centered narrowly around selective recent IPO listings KTL Global and First Resource as well as crude palm oil (CPO) plays. However, short-term interest among recent IPO plays has waned. Our CPO preferred pick First Resource surged briefly beyond the maximum short-term technical potential of $1.90 (peak of $1.95 or +30% gain) before succumbing to profit taking.

Inflation and margin pressure worries weigh down on S-chips

While commodity related stocks rode on escalating raw material prices, manufacturers are suffering from higher input costs. S-chips were also sold down last week as investors grew increasingly worried about the impact of escalating oil and commodity prices on profit margins.

Concerned about public anger over escalating prices of basic necessities, the Chinese government will introduce partial price freezes on basic commodities such as gas and oil while price rises for water, petrol, heating, public transport and school fees will be banned.

To contain inflation, the Chinese government could also allow the RMB to appreciate. But this will also make Chinese exports less attractive. DBS Research expects the RMB to appreciate 10% to 6.7 against the USD this year.

Another source of S-chip weakness is the potential unwinding of long positions. While property and bank stocks started to weaken at the start of 2H last year and the technology sector has been weak for a long while, S-chips enjoyed a 4Q07 rally on optimism of QDII fund inflows.

S-chips may be more heavily owned compared to the other groups. Given the current market uncertainty, S-chips are more prone to weakness should nervous investors decide to adopt a ‘sell now buy back later’ strategy.

Textile and fiber (T&F) stocks were sold off in the latter part of last week on concerns about the impact of high oil price. China Sky broke below the technical support of $1.84 on Friday, turning this level into a resistance point. There is downward bias towards $1.43 to 1.53.

Fibrechem also broke below its technical support of $1.26 last week and traded as low as $1.04. The stock could drift towards $0.94 before rebounding. T&F stocks China Sky, Fibrechem, C&G Industrial and Sino Techfibre are now trading below their 200-day moving average.

Rising oil price could also impact PET bottle manufacturer Full Apex and chemical plays such as SP Chemical, whose raw materials are oil based. Shares of Full Apex and SP Chemical are also trading below their 200-day moving averages.

Escalating soybean price have taken their toll on the shares of Pine Agritech and Celestial Nutrifood, corn price on Luzhou Bio-chem and China Sun, live pigs on People’s Food.

Synear could be affected by a combination of rising pork, flour and packaging materials prices. Technically, the stock is struggling below its 200-day moving average while the 60-day moving average has just cut below the 200-day moving average, indicating a weakening technical trend. The stock looks in danger of falling below $1.50.

Price competition is also another factor to watch for. China Hongxing could face increasing competition against its larger competitors Li Ning and Anta. The recent equity rising exercise has also diluted EPS. The stock is currently trading at a FY08F PE of 22.5X. The technical trend looks weak. It dipped marginally below the 200-day moving average on Friday and looks in danger of falling below $0.845 down towards $0.71.

Substantial shareholders reducing stakes on several prominent S-chips also marred the week:

1. Baring Asset Management ceased to ba a substantial shareholder of Yangzijiang following the sale of 8.45mil shares.

The stock finally cracked down below its recent low of $1.85 last Friday.

2. Legg Mason’s stake in Jiutian Chemical is reduced to 6.72% through the sale of more than 7mil shares.

The stock plummeted below Nov07 low of $0.42 last Tuesday on worries about margin squeeze for its key product DMF following price cuts by major competitor Hualu. Technical resistance is now at $0.34.

Short-term overhang pressure is likely to put a price cap on the stock given the high average daily trading volume of 38.3mil shares last week. This is higher than the average volume 17.7mil shares over the past 60 trading days. Avoid the stock until the overhang tapers off.

3. JF Asset Management reduced its stake in Celestial Nutrifoods by 6.5mil shares to 7.86%.

The stock had been weighed down by concerns about escalating soybean prices on margins.

On a less somber note, DBS Research’s positive view on the hospitality sector. CDL Hospitality Trust gained 6.25% for the week to $2.55. The current construction boom saw Lian Beng reporting a nearly 4-fold increase in 1H08 earnings to S$8.1mil as revenue gained 23% to S$106.3mil. However, affected by the weak market sentiment, the stock was sold off on news.
Construction plays could be a sector to position into once market sentiment improves.

Straits Times Index Technical Outlook

While the market breadth indicator slipped further to -33.7, the reading is still not low enough to signal a market bottom. Typically, an index bottom occurs after the indicator falls to -60 to -100 and starts to exhibit positive divergence against the ST Index. There are currently no signs of that development at all.

The newly launched FTSE ST Index broke below the 3300 psychological support on Friday.

We maintain our view that the index should head towards 3000 by the end of 1Q.