Market View

06 Feb 2009 : At this point we are experiencing a small rally but there are many stumbling blocks in the weeks ahead including many of S&P companies reporting earnings and more importantly US economic data.

Barry Shamley, manager of the Equinox Managed Portfolios writes that January 2009 was the worst January on record for the S&P 500. The S&P fell -8.57%, FTSE -6.42%, Nikkei -9.77%, Hang Seng -7.71%,and Russia -15.33%. The JSE suffered less (-4.37%) thanks partly to our Gold index which gained 17.04% on the back of a 12.6% rise in the Rand Gold price as well as lower costs being reported by the miners.

Most other commodities were firmer but to a smaller extent with copper up 2.7%, Brent crude +7.6% and platinum up 4.89%. The Rand weakened significantly from R9.40 to R10.20 as risk appetite contracted.

The leading indicator for the current bear market has been US banks which have suffered as a result of lending money to people to buy houses that were overpriced without doing sufficient credit checks on them (ie subprime). Simplistically this has resulted in a heavily indebted US consumer who now cannot pay his mortgage, has no money left to repay any other debt or spend on consumables.

This in turn affects retailers and manufactures who are forced to retrench staff due to lower demand. The problem has therefore snowballed for these banks to such an extent that many are being nationalized both in the US and UK and in turn wiping out equity investors in most cases. US banks were down over 36% in January 2009 and are down approximately 80% from their highs in early 2007, (see chart below).

It is widely expected that US housing, which led us into this recession, will lead us out. It is therefore wise to keep a close eye on home sales, house prices and in particular the unsold inventory of houses. Once the inventory of unsold homes returns to historic averages only then will prices stabilize. In 2008 US property values lost $3.3 trillion.

Locally our banks and industrials are still performing reasonably well compared to their overseas counterparts. This is as a result of our banks not having exposure to offshore subprime as well as the timely implementation of the National Credit Act. It would be foolish to believe that we will remain unaffected by the global e consolidation period. This often happens after long bear markets.

Investors become disillusioned with equity markets and prefer to keep their savings in bank or money market accounts as it takes a long time for confidence to grow. What will be a key determinant will be growth in Asia and specifically China. If this is able to resume its growth in coming years despite a considerably weaker US consumer then the outlook for SA (a commodity exporter) improves considerably.

A growing concern is the potential for high inflation to rear its head again. In past global crises the US and other countries to a smaller extent have worked their way out of it by increasing credit availability (and therefore creating a heavily indebted consumer). Economic growth becomes reliant on debt which in the long term has disastrous consequences which are visible now. It seems the same solution is being attempted again with US and UK lowering interest rates to record lows.

Given the very low velocity of money, (the speed at which money changes hands) the effect is stunted at this point but as their efforts gain traction the possibility for high inflation becomes real. This suits these governments as they are selling record amounts of government debt and incurring immense obligations for future generations. High inflation effectively reduces this debt size. The point I am making is that there is a good chance of commodity prices increasing significantly in the medium term as people try to avoid the value of their assets being reduced by holding paper money. This seems to be one of the reasons why the gold price has been so strong, (the other being its safe haven status). See chart of gold price below.

We are still in a seasonably good period for equity markets. Januarys equity market performance was very disappointing and in the course of the month we did reduce equity exposure back to 20% after seeing US banks, (the leading indicator) falling to new lows. At this point we are experiencing a small rally but there are many stumbling blocks in the weeks ahead including many of S&P companies reporting earnings and more importantly US economic data.

We feel comfortable with our 20% exposure but will keep a close eye on all developments. Sentiment is very poor globally which is normally a good contra indicator but given our commitment to capital preservation we will tread cautiously in the weeks ahead until things become clearer and we are able to act with higher conviction.