The United States Subprime Mortgage Crisis

The Malaysian market was quiet for a while after the dreadful Dotcom Internet Bubble in2001. Investors and speculators were licking their wounds and recurerating from the losses during the Dotcom Internet Bubble.  It took a period of more than five years for the KLCI to recover 60% to 914 points by middle of year 2006, or about 10% a year. That to me was a reasonable recovery. After that, it took less than one and a half year to race up by an equal amount of 60% to a new peak of 1445 points on 30^th November 2007 as shown in Figure 1 below. The party was on again.

One of my “favorite” stocks, KNM, went up to the adjusted price of more than RM10 then, with its fantastic growth story and acquisitions all over the world. Wow, Malaysia has produced such a woderful global growth giant. Many investors including big institutional investors, EPF included, bought into the stories expounded by the management and flamboyant CEO, a great talking head, with the undivided support of all investment bankers and professional analysts. With the help of syndicates, I believe, rammed up the share price above RM10 in a short time. Unfortunately it became one of the worst performer after the crisis, dropping by more than 90%. It is now traded at 63 sen eight years later on 31^st March 2015, only at a few percentage point of its peak price.

Figure 1: KLCI at The US Sublime Crisis

The US Market

The subprime mortgage crisis in mid 2000s was one of the most spectacular episodes in the history of US capital market. The housing market was in steep rise in the mid-2000s. The innovative financial tools of adjusted mortgage interest rates, no down payment no income verification mortgages, allowed lenders to lend to subprime borrowers who without them would never be able to qualify for the loans and able to pay for the loan instalments as they simply did not have the income to support them. When house prices rose, it appeared everything was alright as their equity in the house appreciated and they could continue to borrow more with the increased equity they had in their houses. When the steep rise in house prices reversed its trend, and as adjustable mortgage interest rates reset, borrowers defaulted, triggering a financial crisis which spread to every corner of the globe. This was exaggerated by the securitization of the loans and mortgages which were sold widespread into the institutional investor market which turned sour due to the widespread default of the housing loans. This created a dominos effect resulting drying up of liquidity that shows no signs of ending.

The S&P 500 Index dropped 52% in less than one and a half year from October 2007 to February 2009. The crisis was so severe that two famous and established investment banks, Bear Sterns and Lemon Brothers which both had survived many pass crisis, went belly up due to their heavy exposure to the subprime mortgage debt securities. The US stock market was hit by many six sigma events which no financial models can predict. There were large and frequent drops of the indices of a few percent a day which were never supposed to happen, so according to the financial models such as that of Value At Risk. Many hedge funds collapse and gone bankrupt. During that time, banks were not willing to even lend money to other banks. Citi Bank shares, the once largest bank capitalization stock dropped to historical low of just $1. Those who lived through these events will never forget the turmoil.

Bursa Malaysia

As the US Sublime Housing Crisis intensified, KCI dropped in tandem with the US market. It suffered the worst one-day plunge of 130 points or 9.5% on 10 March 2008 to 1157 points as a reaction exaggerated by the results of the 12^th General Election.

Sime Darby fell RM1.90 to RM9.10, KPS lost RM1.74 to RM1.68, DiGi RM1.70 to RM21.30 while BCHB fell RM1.65 to RM8.55. Other losers were IJM, down RM1.45 to RM5.50, Puncak RM1.36 to RM3.16, Tenaga RM1.25 to RM7.40 and Bursa RM1.05 to RMN8.90. Source: The Star On-Line (10.03.2008)

The KLCI had lost 40% in 10 months from end of October to a low of 864 points at the end of September 2008. Those hot growth stocks which were bidden up to lofty valuation with rosy future expectations fell many times more than the broad market. KNM dropped to its low at RM1.44, or a loss of 86%, in just one year. Incredible! However, it was still not too bad considering it dropped to low of less than 40 sen two years ago, and now trading at 70 sen at the close on 26^th March 2015.

Other big losers were Zelan, down by 84% from RM5.50 to 88 sen for the year 2008, now only at 31.5 sen; Pelikan by 75% from RM4.90 to RM1.21, now still about the same at RM1.17. BHIC, the ship builder which has been getting huge projects from the Malaysian Navy and from the government largess, appeared to be “sure win” company, lost 62% from RM7.50 to RM2.85. At RM2.19 now, shareholders of BHIC aare still leaking their wounds and continued to suffer.

Even seemingly good stocks were not spared. Parkson lost 60% from RM10 to RM4.00. At RM2.07 now, investors are still crying without tears. CBIP was down by 72% to RM1.70, the difference is that its price now at RM2.07 after the one for one bonus and free warrants, has already recovered above its previous peak before the plunge. Similarly for Genting. Now at RM9.00, has recovered above its 2008 peak price of RM7.80. Same for KLK etc. However, if you have paid too much for good stocks at their peaks such as IJM at RM8.50, you still have not recovered your loss yet seven years later.

It is noted that the steep fall of stock prices in 2008 for KLCI did not affect good stocks which were selling at reasonable prices at the beginning of the year. BAT, F&N, JT International, Nestle, Amway, Engtex, VADS etc in fact rose in prices during the year. Their share prices as at to date are much higher, for example BAT is 54% above its peak in 2008, not including all the generous dividends investors have been receiving. F&N at RM18.20, is 106% above its peak in 2008 of RM8.85. Amway at RM10.90 is 58% above its 2008 peak price of RM6.90.

What if you can recognize the opportunity above and instead of investing in the blue chips as above, you invested in some good smaller companies selling at much better bargain prices then?

We will discuss about this in the next episode using the experience I had. Meanwhile for those who wish to learn about how to identify good companies and how to check if they are selling at bargain price please contact me at:

ckc15training2@gmail.com.

Being able to identify good companies at cheap price has been proven again and again that it is a winning investing strategy in the long term.

K CChong (3rd April 2015)