ONE method employed by analysts to determine investment strategy is to assign probabilities to various scenarios using their judgement. Thus far, a loose consensus appears to be that there is a 30-40 per cent chance of Greece defaulting on its debt and exiting the eurozone, the dreaded "Grexit" as it has become known.
By the same token though, most observers believe a full-scale contagion collapse will not occur, simply because the stakes are too high and European governments won't allow it to happen. (Then again, these are the same observers who were calling for robust US growth this year before the release of Friday's dismal figures, and for the eurozone to avoid a recession. But we digress.)
Professional investor Schroders also believes a full-scale collapse is not on the cards but offers a slightly different view - it believes a Grexit is not an question of "if" but "when". In its Economic and Strategy Viewpoint last week, it described the stand-off between Greece and the European Union as a game of "chicken" but added somewhat soberly that there is likely to be an unhappy ending.
"We do not see a happy outcome and have brought forward our assumption of a Greek departure from the euro to the third quarter of this year, as the EU and ECB cut off funding," said Schroders.
It said it then expects the European Central Bank to unite with central banks around the world to pump liquidity into the system to limit contagion and prevent a further break-up of the euro.
Morgan Stanley applied a scenario-weighted probability analysis to its Emerging Markets (EM) strategy last week, assigning a 15 per cent chance of a bull scenario unfolding (2012 global growth of 4.2 per cent, EM growth of 6.5 per cent), a 55 per cent base scenario (global 3.5 per cent, EM 5.7 per cent), a 20 per cent bear scenario (global 1.9 per cent, EM 4.3 per cent), and a 10 per cent extreme bear scenario where a recession similar to or worse than 2008/9 develops. Using various trailing price/earnings assumptions for each scenario, the investment bank arrived at a price target for its MSCI EM Index of 1,210 compared to about 906 now. It said although it has cut its "overweight" on equities to just 8 per cent, it is now looking to re-invest and that a "W"-shaped trough is likely.
Investors in Facebook might also be hoping for a trough of sorts soon, judging by the social network's dismal post-IPO performance. Amid much hype the stock was floated at US$38, but it now sells for US$27.72, a loss of 27 per cent in a fortnight.
Much has been written about the company and its IPO but going through the comments, one thing emerges - the stock was in all likelihood grossly overvalued when it was listed and is simply now settling back to fair value.
As one commentator put it, Facebook's problem is that it's a good company which makes money, but it doesn't make that much money and it doesn't have an obvious way to make significantly more money because like many other Internet companies, it hasn't figured out a way to monetise its millions of users.
If we were to assign probabilities to the case of Facebook, our guess would be that apart from a 100 per cent chance that the stock was overvalued, there is 51 per cent chance it will drop to half its IPO price before bottoming out and finding a base.
As for where the Straits Times Index's bottom might be, our guess is that there is a better-than-even chance that the index, having lost almost all its 2012 gains in the past eight weeks - it is still 3.75 per cent up for the year though - will continue to endure heightened volatility in the weeks leading up to Greece's June 17 elections. Friday's plunge in Western markets will reverberate in this part of the world and trading funds will continue alternating between going short and long. The odds for the moment favour going short.