Dark economic clouds have a silver lining

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By Jeremy Gardiner

The first half of 2008 saw world markets having to cope with an inordinate amount of bad news. The Americans had it the worst, as they were battered by the ravages of subprime, a collapsing housing market and a banking system under severe pressure.

Worldwide we have seen rising food prices, oil prices, inflation and unemployment, coupled with falling growth, consumer confidence, consumer spending, lending activity, housing activity, property prices, earnings and share prices. And it’s not over yet.

Although subprime is working its way though the system, the world is short of capital. Banks won’t lend to each other; they are reluctant to lend to consumers; consumers are equally reluctant to borrow and as a result asset prices are falling. (Essentially, anything that requires a loan to buy is vulnerable.)

The above factors have wreaked havoc on equities and economies worldwide. However, there is some cause for optimism:

1. We are probably around 60% of the way through the subprime debacle. Investment bank write-downs should be over by the end of the year. Of course, it will take a couple of years before banks start lending freely again and confidence returns, but conditions should gradually start improving.

2. Oil has been through the worst of times, suffering from demand problems, supply problems, speculative problems and geopolitical problems. We should see some relief in certain of these areas going forward, which means that although in the short term oil may test $150 dollars a barrel and possibly even $175, in the long term it should trend back to closer to $100 a barrel.

3. America is not yet in recession and in fact may not even go into recession. Growth is surprising on the upside and although slowing quite significantly, efforts by the US Fed and Government seem to have stabilised the situation.

4. China and the developing world are strong. Although Chinese growth will probably slow a bit, on the whole, domestic Asian demand will see them continue to power ahead despite the slowdown in the West. In addition, they subsidise their fuel prices and they are net exporters of grain and fertiliser, so they are largely immune to food and fuel price increases, plus they have a balance of payments surplus of roughly 10%.

5. Commodity prices and shares have experienced a necessary pullback. However, the story remains fundamentally sound and at some stage strength will return to the sector.

6. South African growth is slowing along with the rest of the world, but a GDP recession is highly unlikely. Inflation looks set to come down quite significantly over the next year and with it interest rates as well, bringing some much needed relief to consumers.

7. After a rough start to the year, the rand has been typically volatile. However, given the size of the current account deficit in South Africa, the currency remains vulnerable.

8. Food prices have stabilised and in some cases (particularly maize) have corrected sharply.

So what should investors be doing? Revert back to basic rules during turbulent times. Very simply, this means buy cheap and sell expensive, and hold investments for a minimum of three to four years. Investors should realise by now that commodity shares, although an important part of any portfolio, can be risky and therefore need to be positioned appropriately in their portfolios according to their risk profile.

Be careful of sitting too heavily in cash. While it would be nice to wait until it feels comfortable to invest again, by the time it feels comfortable, it may no longer be profitable to do so. Opportunities most often present themselves when times are tough.

Source: Jeremy Gardiner, Investec Asset Management, August 18, 2008.


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