Is the recovery overdone?
Every economic presentation we’ve attended since June 2009 has focused on a single concept. Is the equity market recovery overdone? Analysts are voicing the concerns of ordinary stock market investors who cannot believe the 100% plus surge (in dollar terms) in locally listed share prices since March this year. To establish whether private investors are in for further upside we must assess prospects on the world stage. If we know where the United States and other developed economies are heading we can make more certain predictions for South Africa.
What’s happening on the global stage? To find out we attended an economic presentation by ACPI TriAlpha chief executive, Alok Oberoi. His assessment was based, in part, on ‘grass roots’ information gleaned from the 140 global companies the group has been following for almost two decades!
Corporate earnings remain crucial for economic recovery
Oberoi’s first observation was that the turnaround in the United States was already underway. He used tow ‘predictive’ data series to confirm this sentiment. The first compared real US GDP growth with the Institute for Supply Management’s New Orders index. This graph points to a three to six month ‘V’ shaped economic recovery. The second chart was the Global Diffusion Index which accurately predicts market turning points. “The numbers suggest a [continued] recovery in the next three to six months!” said Oberoi.
Will US equities hold on to their recent gains? Analysts agree that corporate earnings are critical for the equity market recovery to sustain momentum. Provided these numbers come in better than expected, investors will continue to back equities. Oberoi said the third quarter US corporate earnings reports – due out in the first two weeks of October – would provide a critical early indication of business prospects through the first half of 2010. He said companies like Federal Express provide an excellent proxy for the health of the overall US economy.
A market correction is closer than you think
Subject to earnings certainty investors must proceed with extreme caution. There is no doubt the S&P 500 index is overbought at the moment, and investors are getting nervous following 26 consecutive weeks of uninterrupted share price gains! Under these conditions one of two scenarios will play out over the next six months. One is for equity prices to trend sideways while the overbought situation dissipates. The alternative is a sharp market correction followed by a second stage recovery.
Although fundamental analysts warn against making market predictions based on historical price data we shouldn’t discard price history when forecasting short-term market trends. A study of market collapses and subsequent corrections proves telling in this regard. Oberoi says that post-recession equity market rallies are often punctuated by price corrections. Historically, post-crash market recoveries are interrupted by pullbacks of 12.4% with an average duration of 2.75 months. So although the market has been ‘firing on all cylinders’ since March 2009, history suggests we might have to endure a 12% correction!
Inflation is not a threat – yet!
Inflation is one of the major threats to long-term economic recovery. Oberoi believes the developed world will avoid this challenge over the next 12 to 18 months. Instead, the real challenge is deflation. Why did he say this? The first reason is the money that flowed into developed economies through the financial crisis went to plugging holes in balance sheets rather than stimulating consumption expenditure. “The money was selectively placed to recapitalise banks and [allow time for earnings recovery while banks restructured] their loan books,” said Oberoi. The amount of credit available to private sector companies in the US (and the rest of the developed world) is tight, and likely to remain so over the next two to three years.
A second blow to the inflation argument is the major global overcapacity situation. “Usually inflation is caused by capacity constraints,” said Oberoi, but there’s no sign of that this time round. The overcapacity situation is exacerbated by the emerging economies bringing loads of low cost capacity on line in recent years.
What should investors do?
Investors will have to search for the best market opportunities. In the medium term TriAlpha remain bullish on the so-called BRIC nations: Brazil, Russia, India and China. The big growth opportunities will emerge from cross-trading opportunities between these emerging economies, said Oberoi. He believes there will be many opportunities as China extends its African reach. Under these conditions equities remain your best bet. “The only liquid room to take some risk is equities,” said Oberoi. He warned however that equities could not be considered cheap at present. Investors will have to select their shares and sectors carefully!
Editor’s thoughts:
At the height of the global financial crisis it seemed like share prices were on a hiding to nothing. Investors have since chased share prices far higher than the real economic data suggests is reasonable. Were you surprised by the speed of the South African share price recovery? Add your comments below, or send them to [email protected]
