Unsettling but not surprising...

Gareth Stokes, FAnews Online Editor

On Thursday, 10 March 2011, the JSE All Share index shed 2.9%, closing at 30, 899 points. Try as they might investors haven’t been able to chase the local bourse to a closing level beyond its 22 May 2008 record of 33 233 points. They came close on Valenti

Investors are crawling back into their shells as civilian unrest in the Middle East and North Africa morphs into civil war in Libya and the Ivory Coast. Against this backdrop the slightest bit of negative news can trigger a stock market avalanche. On a day when ratings agency Moody’s downgraded Spain (adding to already significant fears of a sovereign debt meltdown in the Euro-zone), the US published worse than expected initial jobless claims and China reported a surplus trade deficit there was nothing to prevent a bloodbath on bourses worldwide. How should investors respond to these events?

Take a long term view – tune out the day-to-day static

Analysts warn against taking a day-to-day view on stock market price movements… Savers need to consider their equity investment track record over the longer term, making small tweaks when they review performances on (at most) a quarterly basis. They cannot afford to take knee-jerk decisions each time the market hiccups. To find out more about what long-term investors should be concerned about we’ll consider some of the views expressed by Adrian Saville, chief investment officer of Cannon Asset Managers recently. In his article “The emperor has no clothes and other investment myths” Saville exposes the investment risks that dominate the market early in 2011.

Stock markets move in cycles. The share prices on any major bourse are supposed to advance and recede on reasonably accurate market information – expectations of earnings, employment, GDP etc. In reality major market movements stem from investor sentiment. “Since the onset of the global financial crisis, investors seem to have surged from risk loving to risk fearing and back to risk loving again,” says Saville. He questions whether the risks dominating the global economic environment through the 2008 financial crisis and subsequent recession have subsided. “Whilst there is an overwhelming sense that risks have waned in the last year, there is a lot of evidence to suggest significant risks remain in both capital and financial markets,” he says.

Investors are only “seeing” 10% of the problem

Ignoring risk can have fatal consequences… On 10 April 1912 the then largest passenger steamship, the RMS Titanic, set out on her maiden voyage from Southampton harbour to New York. The captain and ship builder, keen to impress the world by making good speed on the crossing, ignored ice warnings and ploughed into an iceberg on the morning of 14 April. Their decision sent 1517 passengers to a watery grave. Not only did they ignore risk – but forgot how much of the risk exists out of sight. The bulk of the iceberg threat is hidden from view below the ocean’s surface. In much the same way investors entered 2011 at breakneck speed. They have ignored the looming threats (icebergs) and powered ahead blissfully unaware of how much trouble is lurking just below the surface...

The first of these icebergs is sovereign debt. “It has been the case for some time that national debt amongst some of the world’s biggest economies (as well as smaller ones) is too high,” says Saville. The debt-to-GDP ratio has crawled way beyond the economically acceptable 60% in many countries. The United States, Japan, Vietnam and a number of the PIIGS (Portugal, Italy, Ireland, Greece and Spain) started 2011 with debt-to-GDP ratios well in excess of 180%. That’s the equivalent of one of us beginning the New Year owing 1.8 times our annual salaries!

In keeping with our iceberg analogy Saville warns that much of the developed world debt is actually held “off balance sheet in the form of future spending obligations on [mainly] social welfare commitments.” The South African debt-to-GDP ratio is hovering in the 40% to 50% range, quite manageable until you factor in “promises” such as National Health Insurance (with a price tag easily topping R100 billion a year) and benefits for so-called military veterans (already pencilled in at R60 billion).

Investing in turbulent times

“In this environment there are exceptional opportunities but also clear traps in terms of investment risk which we need to take into account,” says Saville. He suggests the value approach as one of the best risk deterrents available to local investors, but laments our reluctance to follow it. The world’s greatest value investor – Warren Buffett – advocates holding a good company “forever”. Instead the average investor is “churning” his portfolio more frequently than ever before.

Saville backs this observation with some statistics: “If we look at a metric such as the holding period for shares, we see that market average has slumped from 25 years in the 1970s to some one-and-a-half years in the 2000s!” He believes the four-and-a-half year average holding period at Cannon Asset Managers establishes the group as an investor rather than a speculator. He warned investors against backing shares at ever-higher prices, and dumping them when prices fell. “This behaviour turns the foundation of successful investing – buy low and sell high – on its head,” he says. “Paying too much for a share turns a great business into a bad investment!”

Editor’s thoughts: As we advance through the 21^st Century life flashes by at a much faster pace. We have become a society of “fad” chasers – we want today’s hi-tech gadget, today’s fashion, today’s car and – of course – today’s share. The result is a “chop and change” attitude to just about every aspect of our lives… It’s this never ending quest for satisfaction which damages our long-term investment performance. Are you one of the investors that chases after the share of the moment? Add your comment below, or send it to gareth@fanews.co.za