Never throw stones at a bear
What were the Americans thinking? They made all kinds of promises to ailing banks and financial institutions when they proposed a $700bn rescue package recently. But when the US House of Representatives voted on the issue it was defeated 228 votes to 205. As far as markets are concerned it’s like throwing stones at a bear – you might just wake it up. And when it wakes it’s going to be mean as hell! US investors wasted little time in telling the world what they thought of the failed rescue package. They sold stocks like there was no tomorrow, with the Dow Jones Index falling by its largest single day points margin ever. The worst thing is that Monday’s 778 point slide will send international investors diving for cover this Tuesday – and probably for the rest of the week too.
We’ll finish this newsletter minutes before the JSE opens; but if yesterday is anything to go by local investors are going to take another massive hit. Even though our markets closed before the failed US rescue vote, local investors were already dumping blue chip shares on Monday. The JSE All Share Index shed 1 412 points with the once-invincible resources index leading the way, down 8.22% on the day.
Has the bear woken up?
Are we in a sustained bear market or have we simply entered a period of extreme volatility? This was the question asked at a Sanlam Private Investments media briefing presented by chief executive Daniel Kriel and economist Alwyn van der Merwe. They both agree that we cannot make such a determination based on a single day’s trade. But we cannot ignore what’s been happening on domestic markets in the last six to 18 months. The fantastic equity market performance we’ve become accustomed to since 2003 is a thing of the past. Van der Merwe demonstrates this with a chart of 12-Month JSE All Share performance which has dipped into negative territory for the first time in more than five years. He notes that the year-on-year performance of equities in South Africa could remain negative for an extended period of time.
Bear markets are tough to identify. A textbook definition calls for a decline in general price levels of more than 20% with an extended duration. During bear markets we often see rallies on low volumes; but never strong enough to break the downward trend. The common causes of bear markets include a disconnect between price and value, high prices (often fuelled by credit extension) and a downward price spiral due to negative news, speculation, panic and forced trades. We could argue that most of these factors are in play in South Africa today. There has certainly been a shift in sentiment as domestic share traders and investors battle to digest a steady flow of negative news. Since December 2007 we’ve had Polokwane, Eskom, legal challenges to senior politicians, high inflation, soaring interest rates and $150 per barrel oil. And the global outlook is as treacherous as quicksand.
A look at financial shares going back 14 months suggests that certain sectors of our economy might already pass the bear market criteria… Our banks may not suffer similar exposure to reckless lending practices as those in the US and UK; but they’ll lose further value as their international counterparts go under.
Crazy situation in the states
We like to think of the US sub-prime crisis as the result of building paper castles. There are simply too many flimsy paper assets backed by nothing more than similarly flimsy paper assets. When you eventually get to the bottom of a particular paper trail there’s nothing of substance to cover the debt... That’s why $44trn was wiped off global equity markets in September this year. It’s also led to an absurd situation where US 3-month Treasuries are trading at 0.02%. The US financial markets are so skittish right now that investors are paying the US government (in real terms) to keep their money in safe custody.
What should investors do? Van der Merwe says the best option is to stick with your long-term view. Equities should always offer the best real return over 20-years or more. But for the next year or two equities will remain the “most volatile asset class.” This said there are some reasons for hope. Van der Merwe identified a number of factors that should support SA equities going forward. Valuations are reasonable, inflation and interest rates are set to cool in 2009, earnings should rebound in 2010 and institutional investors have high cash holdings. Everything points to a solid recovery once the global financial crisis runs its course.
Editor’s thoughts:
Although equities provide the best return over a longer period of time you’d be crazy to expect much over the next 12 to 24 months. Choosing shares that will outperform the JSE All Share Index might be possible; but who wants to crow about a 6% to 10% capital decline when an Index falls by 15% or more? Would you be pouring fresh money into equities now, or would you rather sit on the sidelines? Add your comments below, or send them to [email protected]
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