SIM: Economic crisis corrodes investor confidence

Sanlam Investment Management (SIM) Investor Confidence Index, conducted by the Institute of Behavioural Finance, indicates new low in October

With the severity of the economic crisis constantly highlighted by global central banks and the media - and some commentators likening the current situation to the Great Depression - it was not surprising to see the SIM Investor Confidence Index, hit a new low in October. Many investors, particularly institutional investors, indicated increased concern about the possibility of a 1930’s type market crash occurring.

In addition, more investors deemed the market to be too cheap, and although investors were not becoming more positive about returns from the equity market over a one year period, institutional investors, in particular, had become more positive on expected short term returns.

Frederick White (pictured), head of SIM research and process says, “From a certain perspective one could ask whether we haven’t already seen a crash that is comparable to that of 1929, because in US$ terms the peak-to-trough decline in the JSE All Share index over the last year has been a massive 60 percent.”

From 15 September to 15 October, global equity markets lost almost a quarter of their value with the MSCI world index down 23 percent, S&P500 index down 24 percent. Although at face value, the JSE All Share index (ALSI) lost only 20 percent during that period, to some extent the real loss was masked by the weakness in the currency. In actual fact, when compared in same currency terms (US$), the ALSI actually lost almost 40 percent of its value.”

“The initial drop in 1929 saw markets down 40 percent in just over two months, very similar to the market movements we have experienced recently. The sad reality is that the 1929 crash in the US lasted almost three years and saw stocks decline 89 percent peak-to-trough. To match such a move after a 60 percent decline would require another 73 percent decline from current levels.”

White believes that the widespread loss of investor confidence is ultimately the root of the market turmoil. “After the shock collapse of some major players, global financial institutions have become reluctant to take the risk of lending money to each other and to other parties, since they cannot judge the counterparty risk. Investors are unable to forecast the impact of tighter, more expensive credit (combined with a constrained consumer), on corporate earnings,” says White.

“While this financial crisis is happening, economic growth everywhere is slowing down rapidly. Credit extension and a well-oiled financial system are key components of a normal economic recovery mechanism. With these elements currently being ‘out of order,’ there is even less visibility than normal on the prospects for, or timing of, any recovery” he says.

Consequently the default risk on all corporates has risen. Given all this uncertainty, investors are demanding a much higher equity risk premium, but are struggling to figure out how much.

The Index indicated for the first time ever, that more than half of all respondents (57 percent) deemed the probability of a “1930s type” market crash to be more than 10 percent, with the average probability of such a crash estimated at 25 percent - a one in four chance - up from 19 percent a month ago,” he said.

“Again it was the institutional investors who were especially worried about the possibility of a crash. Within this group 77 percent deemed the probability of a crash to be above 10 percent, with the average probability estimated at 33.3 percent – a one in three chance.”

The October survey also saw a big increase (to 68 percent, from 42 percent) in the number of respondents considering the market to be too cheap. “However, despite this positive development with respect to valuation, investors are not becoming more positive yet about the returns they expect from the equity market. Over a one year period the market is expected to rise just less that eight percent. This conservative expectation when the market is deemed to be cheap - and has just fallen severely - illustrates investors’ awareness of current forecast risks and an inability to ascertain how long the economic decline will last,” he says.

Investors have, however, become much more positive about the short-term returns expected from the market, with the institutional investors, in particular, increasing their short-term expected returns very materially. More than 75 percent of institutional respondents expect the market to rise over both the three month and six month horizons. “On a three month basis, they expect the market to rise by 5.2 percent and on a six month basis by six percent (the average for all respondents is 3.3 and 4.3 percent respectively over the time periods).”

These rises are very optimistic relative to the rise expected on a one year basis. He believes they suggest that there is a significant group of investors who expect a relief rally in the next couple of months but, in line with the unclear future, no sustained rise thereafter.