Equity markets: A double edged sword
Two clear messages emerged from SA investors in the results of the July 2008 Sanlam Investment Management (SIM) Investor Confidence Index, a monthly measure of sentiment among investment professionals and financial planners. On the one hand there were increased concerns with respect to short-term returns from equity markets, but on the other, investors expressed a distinct perception that the equity market is starting to offer value.
The market drivers and circumstances around the time of the survey are likely to have had a big impact on the results. Frederick White (pictured), head of research and process at SIM, the asset manager within the Sanlam Group explains, “In the United States, the market became aware that Fannie Mae and Freddie Mac, the government supported entities that underwrite roughly half of the US mortgage market, were under severe financial strain and could actually go bankrupt.
“Not only was this bad news due to the implied weakness in consumer finances and rising mortgage delinquencies, but also because of the potentially severe negative impact it could have on the broader economy,” said White.
“The failure of these entities could have resulted in the collapse of an already weak US mortgage market, triggering further falls in consumer confidence, which is already at multi-decade lows, and pushing an already weak economy into a protracted recession,” he said. During the month to mid-July, US equity markets tumbled by just more than 10 percent, taking equity markets around the world down with them.
White said, “On the local front, economic news flow has been weak, with increasing evidence that the consumer is under pressure and that the cumulative effect of the last two years of monetary tightening, which adds up to a total of five percentage-point rise in interest rates, was making below-trend economic growth increasingly likely.
“Despite this, the consensus outlook for equity earnings remains well above trend, raising the risk of earnings downgrades, which would put further pressure on equity markets,” he said.
Against this backdrop, according to White, local equity investors grew even more negative about the short-term outlook for equity market returns. He said, “We noticed in the previous month’s survey how the one-month and three-month return expectations plunged back into negative territory. In the July survey, these return expectations reduced even further (to about -1.5 percent and -2 percent respectively) and even the six-month return expectation dropped to almost zero, the lowest it has been since inception of the survey. It is only on a 12 month basis that investors increased their return expectation slightly to 5.1 percent, still well below trend return.”
In addition to the nervousness expressed in negative short-term return expectations, investors also expressed a similar message in the post-dip and crash-risk measurements. “For the first time ever, investors expected a 0.7 percent decline in the market on a day following a big dip of three percent or more, while the deemed probability of a 1929 style market crash rose to an all time high of just over 18 percent,” says White.
The timing of the survey had much to do with these views, according to White. “The good news/sentiment that followed the subsequently announced ‘rescue packages’ for Fannie Mae and Freddie Mac would probably have led to different survey results,” he said.
“However, the survey results confirmed that investors’ confidence are real time, and rationally influenced by market developments,” White explains. “If anything posed a risk of causing a big market crash, a collapse in organisations such as Fannie Mae and Freddie Mac would have been it. The increased investor concerns about a potential market crash were reasonable,” White said.
“What is as encouraging from the survey results is investors’ perception that value is now becoming evident in the local market. In the past market declines have not necessarily led to an increase in the perceived value of the market. For instance, in the June survey a large number of respondents expressed a neutral view of market valuation. But following the more than 10 percent decline in local markets since then, it is encouraging to see respondents now consider the market cheap,” he said.
The number of respondents that consider the market to be too cheap has risen to 48 percent from 16 percent last month, outnumbering the 19 percent who deem it to still be too expensive compared with 36 percent last month. “This probably helps explain the severity of the market movements in the couple of days following the survey deadline, when news flow reduced some of the fears depressing the outlook for markets. Consequently the perception of real value led to quite aggressive buying – and a strong rally in the equity market,” White concludes.
