Rudi's View | Apr 03 2008
(This story was first emailed to subscribers on Tuesday)
By Rudi Filapek-Vandyck, editor FNArena
The past ten days have brought us two new trends for global financial markets. Most investors would have picked up the first one, but are likely to have missed the second. If proved correct, both trends will determine the outlook and direction of financial markets in the weeks and months ahead.
Let’s start with the first one, the easy and obvious one. Global equity markets have now suffered the worst of the global debt and credit crisis. At least, that’s the view of a rapidly growing number of market experts. What started with a few experts sticking their neck out about two weeks ago by declaring share markets had seen the lows in this bear market, has now grown into a daily flood of commentary, opinions and views about how global equity markets have now seen the bottom of the barrel. It won’t get any worse than what we’ve seen in the first quarter, is the increasingly popular view, not just in terms of the losses that occurred but also in terms of how low equity markets might fall.
Some of these positive views are based on the fact that governments and central banks will do everything to stop the global credit crunch from taking any more victims. Of course, since Bear Stearns fell over and ended up as a cheap opportunity for JP Morgan Chase, Australia experienced the sudden demise of stockbroker Opes Prime. While this would previously be enough to put this theory to bed, investors no longer fled the market in droves, in essence supporting the view that markets seem to have found their bottom and things can only improve from here on.
Others will refer to the usual contrarian indicators: it’s when overall sentiment is at its worst, and fund managers are holding above average amounts in cash, and retail investors are abandoning the market, and iconic events happen, such as the fall of the fifth largest investment bank in the US, that more often than not financial markets are passing the worst point of their crises. This doesn’t mean we have seen the last of the global liquidity crisis and its impact on financial institutions and geared companies, it’s just that there’s a natural end to the amount of negative news that needs to be priced in before financial assets can start their recovery. If one takes a positive view, that point may well have been reached towards the end of March.
So whereto from here? Well, depending on whether you adhere to this positive view or not, and whether you believe further negative news will gradually diminish in the weeks and months ahead, this might be as good as any other time to re-enter the market, buying relatively cheap assets with a longer term view. As overall confidence grows, these assets will increasingly attract the attention from investors, including those fund managers with lots of cash at hand. Prime candidates are, by default, yesterquarter’s losers such as banks, diversified financials, insurers, property and infrastructure trusts and retailers – because these stocks are cheap and therefore they intrinsically offer the larger potential returns (a small recovery in valuation multiples represents a relatively larger potential investment gain).
However, the problem with such an approach is that you are stock picking in a barrel full of losers. There’s always the danger you might pick the one that was sold down for good reasons. The second problem is that yesterquarter’s losers may be cheap, but they continue to face challenges ahead, such as more US housing woes, a global economic slow down, falling private consumption in Australia and continued tight debt and credit markets.
It is for all these reasons (and the ones you can easily add yourself) that there remains a large group of skeptics who is yet to be convinced that things cannot get worse still, before they ultimately will get better. Note also that many a technical chartist still scoffs at the mere mentioning of “we have seen the low point”.
An update by CommSec Chief Equities Economist Craig James this week confirms that patience is still an investor’s most valuable asset, even if the local share market would now have seen its low. Assuming the Australian economy will remain strong, and taking into account current valuations and the fact the market fell as swiftly as it did in the past four months, James believes the Australian share market may well be able to revisit previous highs by early 2009. He also believes most of the share market gains will likely be booked towards the end of the calendar year with the All Ordinaries/ASX 200 expected to reach 6,350 by December, or more or less the levels at which Australia’s main share market indices entered the calendar year in January. This would imply that sharemarket returns this year will be largely determined by dividend yields.
Which brings us to the second trend: investors saying goodbye to resources, energy and precious metals. This upcoming trend had already been flagged in March, (see my Weekly Analysis from last week) but as the end of the first quarter drew nearer the desire by fund managers and hedge funds to square up at the end of the first three months with some positive results simply outweighed anything else. It is no coincidence that on the first trading days after March 31st most commodities were seen trading in the red. Investors better get used to it, and it will have an effect on listed resources companies.
So why this correction? Well, firstly resources have been yesterquarter’s winners, even though most stocks have struggled to remain in positive territory throughpout the period. Equally important, the number of skeptics regarding the significant outperformance of wheat, oil, gold, copper and aluminium throughout the first three months of calendar 2008 has steadfastily grown. Many investors simply believe the sector is overdue some cooling period and right now seems like the right time.
A process of global deleveraging is taking place and much of the existing leverage, through hedge funds and other investors, has been directed at commodities and commodity stocks. On top of this will come economic data, not only from the US, but also from Japan, from Europe and from various other countries that will point into one direction: slowing growth. This will put investors’ conviction regarding supply and demand dynamics this year to the test. Especially since China will be very much part of this process. Inflation is a growing problem in China, authorities will step up their efforts to cool down the economy towards 9% GDP growth by year-end. This compares with 11%-something only six months ago.
Now you know why some experts don’t believe we have left the worst behind us yet, and why others suggest it will take some time before this market can confidently start moving higher again.
