Investec’s Market Update

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By Jeremy Gardiner

After the worst weekend ever on global markets last week and much activity amongst the G7 and the European finance ministers over the weekend, the world started a fresh week with commitments from international leaders that not only will they do what it takes, but more importantly that they would all do whatever it takes – and do this together.

Up until last week, there were still those who believed that the situation would eventually stabilise itself and that some countries wouldn’t be affected, but what last week taught the world was that consolidated action was needed – and fast.

In my last note, I mentioned that Gordon Brown would try to persuade the world to follow the strategies of the British rescue plan as it addressed far more issues than the US bailout bill and that is roughly exactly what appears to be happening. Full details at this stage are still emerging, however the various deals roughly address the following:

Guarantees on interbank lending
Guarantees on deposits and bank debts
The provision of capital to the point of nationalisation where necessary

Both the G7 and the G20 packages lack detail, however most countries are expected to follow the financial rescue plan set by the UK.

So why are markets still falling?
Last week was the worst week ever for global equity markets. It is therefore highly unlikely that you will see another week like last week again – hopefully – ever. However, the impact of the credit crunch on growth, jobs and earnings is by no means over and will be with us for several years to come. Hopefully stock markets have reached the point at which it is possible for stability to return and hopefully they can start rebuilding at least some of the losses investors have suffered.

Markets, however, are still skittish and they will probably remain so for a while. Volatility is unfortunately going to be with us for some time to come and investors need to understand this fact, accept it, and not allow it to distress them every time markets sell off. South Africans felt that they were isolated or indeed immune from the global crisis. But nobody is immune. Like a tsunami, the tide had momentarily retreated giving us a false sense of security that we wouldn’t get wet. Well, the tsunami hit the Rand this week and economically we will feel this for some time to come.

Is there any good news at all?
Yes, the oil price is roughly 50% of what it was at its peak, and that means lower fuel prices, food prices and ultimately inflation, which will allow central banks to focus more on growth stimulation than fighting inflation. In addition, there are visible signs that interbank lending is starting to loosen; a small pulse is starting to beat again.

What should investors be doing?
These are extraordinary times to say the least. Probably (and hopefully) more extraordinary times than investors will see again in their lifetime. During times such as these, there is an extremely high risk of ‘investment whiplash’, and investors need to be very wary of making extreme portfolio adjustments during current conditions, as the chance of selling/buying at the wrong time is significantly heightened. It is worth remembering that losses on a portfolio are paper losses until the moment investors sell and these losses are actually realised; with time, these losses will be erased.

Similarly, if tempted to buy, there are significant opportunities out there – however investors should look to have at least a three year investment horizon. There is a lot of money sitting on the sidelines trying to time the bottom to signal their buy-in. Similarly, there is a lot of money terrified of further losses and which simply cannot afford to lose more, hence the volatility. The bottom, when it comes, may be with us for a while – so there should be plenty of opportunity to phase funds into the market when it eventually stabilises.

This week’s weakness is being driven by a worsening US economic outlook as well as the fact that Hungary nearly went bankrupt. They have been bailed out with a $5bn loan from the ECB, and so should stay afloat for the moment. Paradoxically, many emerging economies are in better shape than those in the developed world. Fiscal positions are good, savings rates are high and banks are conservatively positioned. These countries are likely to boost domestic demand and increase spending on infrastructure which will in turn provide a renewed global growth dynamic. Finally, many developed market companies – in stark contrast to the banks – have solid balance sheets and sound business franchises. It is these businesses which we believe represent attractive real assets that will endure and grow over the longer term.

As we have stated before, it is times like these that illustrate clearly the benefits of portfolio diversification. Investors with the foresight to diversify according to their specific risk profiles in the good times are now reaping the benefits of protection in the bad. We have weathered crises of our own in South Africa (such as the small cap bubble in 1998). What has helped our clients to survive previous crises was the fact that we diversified their investments into international assets; what will help them to survive international crises like this one will be diversification into local assets. Good diversification is what will help our clients get through challenging times such as these.

Interestingly, despite the fact that Wednesday night’s fall was the worst fall in the US stock market since 1987, this round of weakness feels a bit better. The reason, plainly described, is that the problem has been correctly diagnosed, medication has been prescribed, and the patient has taken the medicine. But, as with all serious illnesses, you have to finish the course of medication. The patient will feel weak for a while, and a period of recovery and recuperation will ensue. However in the short term, the patient may suffer from bouts of nausea.

Source: Jeremy Gardiner, Investec Asset Management, October 17, 2008.


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