My Investing Journey: The scandals of 2004 2 comments

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The year 2004 was actually a year when the market languished in quiet ferment, when the STI went above 2000 but the small-caps as represented by the SESDAQ slowly stagnated or declined (read "Bull Markets and the Wall of Worry"). This could be explained by several factors: consolidation after strong gains in 2H03, plus the sporadically re-emerging triumvirate of US rate hike fears, rising oil prices and US trade deficits.

Although these external/global factors would serve as the wall of worry that had to be scaled, my view is that the major reason for the quiet 2004 market was domestic: it was a background of fear accentuated by a series of corporate scandals involving hitherto market darlings that disrupted market momentum throughout the year, making people uneasy about committing too much money in the markets for fear that their target could be "the next one".

There were a few. Early in the year, Informatics declared heavy provisions for bad and doubtful debts that wiped out all of its earlier declared profits; CAD investigations initiated in the middle of the year revealed aggressive and dishonest revenue recognition. The company's stock price was hit badly and has never recovered since then despite a series of corporate restructurings and recapitalisation exercises.

Later in the year there were several smaller scandals, such as New Lakeside (which reported shocking losses due to provisions right after listing) and Auston (wich had to make significant restatements to past results). At the same time, there was a shocking number of IPOs whose profits collapsed straight after IPO, for example Azeus, Media Asia, Anwell, which sapped investor confidence in SGX oversight, auditor vigilance and corporate governance.

But the real shocker was to come in October 2004, in what was the biggest corporate failure on the SGX ever. China Aviation Oil, a fund manager favourite, declared a massive US$550M loss sustained through its oil derivatives trading, which set it back into negative equity and imminent collapse. It had hitherto been considered THE premier China-themed stock on the SGX. The recriminations went all the way to Beijing, and eventually a high-level task force led the restructuring of the company.

I remember China stocks were hit hard by CAO then, correcting 10% or more the day after the shock announcement of the massive losses. The wariness towards them persisted through the rest of the year. Indeed, I was rocked enough to guide my own purchases with a focus on corporate governance (quality of directors and their independence) plus management commitment to the company (indicated by strong insider purchases). Only with such stringent selection criteria could I be persuaded to hold on to stocks instead of cash.

Today in end-2007 we are at another extreme of the China stock sentiment spectrum, with the announcement of the QDII (Qualified Domestic Institutional Investor) outward investment policy being likely to encompass so-called S-stocks. It may still be pertinent to recall the lessons of 2004 and exercise healthy cynicism when surveying investment opportunities, whether domestic or foreign.