Invest with the headlines at your peril

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By Neels van Schaik

If headlines are meant to catch your attention, Wednesday’s Cape Times headline did its job.

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Admittedly, a 6.4% decline in GDP during the first quarter of 2009 is a shocking figure. But, it is important to realize that this is a historical number that relates to a 3 month period that probably saw the biggest global de-stocking cycle since the Great Depression.  The collapse in leading indicators, commodity prices and stock markets in the second half of 2008 should have told you a recession was on the cards.

The economy is not in free fall. It contracted sharply in the first quarter as a result of the global economic crisis. Recent economic data from around the world and movements in stock markets bear witness to a recent recovery in confidence and global economic activity. The South African economy too will gradually recover from the sharp slowdown in the first quarter.

Investing on the basis of newspaper headlines can be dangerous.

Cast your mind back to the middle of last year when the relentless rise in food and energy prices was all that you read about. The consensus seemed to be that the world was heading into a seventies-style inflationary spiral.

The May 2008 edition of The Economist magazine featured a cover article about the return of inflation (see below). Ironically, this was exactly two months before the peak in global inflation.

The collapse in inflation since has been staggering – refer chart below.

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One thing that we constantly have to remind ourselves is that when everything is going great, things are never as good as they seem, and on the contrary, in very tough times things are usually not as bad as they seem. This is why it is crucial to keep emotions out of investment decisions. We can almost go as far as saying that the best investment decisions are made when you invest contrary to your emotional bias.

Up to mid-2008 many investors were extrapolating the equity returns of the preceding 4 years into the future, despite the fact that stocks were expensive and company profits high. Of course, the correction arrived with a bang and wiped almost 40% of the total JSE’s market capitalization off the table in less than 6 months. The stock market decline went hand in hand with exceptionally negative domestic and global economic news flow. Earlier this year investors were guilty, yet again, of extrapolating this gloom into the future.

We are first to admit that the immediate outlook for employment and a sustained and robust economic recovery looks bleak, but it is unlikely to be as bad as the newspapers want us to believe. And, because we do not have the ability to predict the future, we prefer to invest in assets or companies where we are paying for little, if any, growth. Although this was easier to achieve between November 2008 and March 2009, it is a principle that will yield the best returns over time.

Source: Neels van Schaik, Alphen Asset Management, May 29, 2009.

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