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SCMP Reporter

ALL the world's stock markets are a stage and the final act of this year's tragedy could leave the Hang Seng index below 6,000 points.

  Hong Kong is approaching the grand finale of a full-blown bear market, characterised by three separate 'acts', claims John Schofield of Schroders Securities in a report entitled Anatomy Of A Bear Market.

   This 'maximum bearish' scenario was obtained by applying chartist techniques to previous stock market cycles.

  Startling similarities existed between the lead-up to the 1987 stock market crash and the situation today, Mr Schofield said.

  Wall Street's recent sell-off which had investors cashing in equity portfolios and moving funds into the money markets was part of the 'collective realisation phenomenon' which preceded the final meltdown, he said.

  The trigger that sent investors fleeing from equities, signaling the closing phase of the bear market, was the narrowing gap between bond and equity yields.

 Hong Kong would suffer the full brunt of the crash, conforming to the classic bear pattern of losing at least 50 per cent of its value. It might rally later in 1995, but the possibility of a property bust and the uncertainty of China's economic future made it more likely that it would 'range sideways', Mr Schofield said.

  Unlike the October 1987 crash, a sheer one-day fall was unlikely as the Hang Seng Index had already dropped 25 per cent from its peak, he said.

  Hong Kong equity prices were closely linked to the United States bond market but with a time lag of three months. As in 1987, real yields had crossed the five per cent threshold, putting in place the main precursor to a crash, he said.

  A narrowing gap between equity and bond yields is a classic indicator for chart analysts, as low-risk bonds offer a similar return to equities which are perceived to have reached the peak of their earnings cycle.

  According to Mr Schofield, the next milestone on the road to ruin is a sustained break past 8,400. On Friday, the Hang Seng Index plunged below 8,400 to close at 8,221.

  The level was seen as psychologically important as it had marked an established resistance level, said Mr Schofield.

  Prices would free-fall by at least as much as the market's previous trading range above 8,400, leaving the index open to a straight-off, 600-point fall when sentiment finally coalesced. That was most likely in the new year, 'typically a time for trend change', he said.

  Wall Street would not suffer the full bear market scenario, losing only 15 to 20 per cent of its value over 1994. Strong earnings growth had reduced stocks' price-earnings ratios and the market was only set for a 'correction of the big cycle, not a full-scale bear market', he said.

  'Chartist' techniques involve measuring past price and yield movements and applying them to present-day situations. This is in contrast to 'fundamentals' analysis which is based on an inductive approach to future trends. Fund managers rarely admit that investment decisions are based on chartist analysis but in reality the two schools often overlap.

  According to Mr Schofield, the classic bear market has three distinct phases of investor psychology. Hong Kong is entering the third phase.

   The initial sell-off. This starts with the sudden realisation that the market has risen too far, too fast. Stock prices become over-valued in a final speculative surge based on extremely optimistic forecasts for earnings.

  After an initial dip followed by a re-test of the market high, a sustained fall sets in. It is widely agreed that stocks are too expensive and a healthy correction is underway.

   The rally. Stock prices stop falling and bargain hunters appear. 'Oversold' is the cry. The rally may fizzle out and give way to a period of sideways ranging. The period is characterised by balanced argument between bulls and bears as to whether stocks are cheap or if further price adjustment is needed.



Stage looks set for a dramatic market plunge