Market View

08 Sep 2007 : August 2007, a historic month. The JSE all share index was 15% down from its July 2007 high at mid-month and bounced back dramatically to end up 0.35%.

Barry Shamley, Equinox Portfolio Manager writes that US Consumers hold the key to the future performance of world equity markets. On the other hand, will a slow down in US consumption affect the Chinese and Indian growth stories?

August 2007 was a historic month as far as global equity markets go. The JSE all share index was almost 15% down from its 27 July 2007 high of 30,041 near the middle of the month and bounced back dramatically to end up 0.35%. The blame for the global sell off was pinned on US Sub prime mortgage debt which had been packaged and sold on all over the globe.

The panic set in as investors were unable to ascertain which financial institutions and investment vehicles had exposure to this debt and what the effect would be to earnings once it was marked to market (priced according to its realizable value). The US markets led the way down and in particular US financial stocks who had the most exposure to this debt. The S&P 500 finally experienced the 10% correction commentators had been looking for but also managed a strong recovery to end the month +1.29% up. The FTSE ended -0.89% lower while Japans Nikkei was the worst developed market performer losing almost 4% after the stronger yen (on the back of investors closing their carry trades) made their exports less competitive.

Commodity markets suffered in line with equity markets. Brent crude lost 7.4%, the copper price fell 6.87% while Gold bucked the trend and strengthened 1.18% in Dollars. On the SA market the gold sector performed terribly losing 13% but most of this was attributable to Harmony’s woes and its CEO’s sudden departure.

As can be expected in a equity market sell off the Rand weakened 1.16% ending the month at R7.16 to the USD as international investors fled from emerging markets and into the perceived safety of US Treasuries. The Rand did trade as low R7.60 to the USD but strengthened as calm returned to the markets.

So where to from here? All of the problems that existed a month ago still exist today. What has changed is that the market has a better idea of which institutions have exposure to sub prime debt. There are bound to be negative trading updates from various financial institutions and hedge funds that specialize in debt and credit derivatives.

Central banks have made efforts to ensure liquidity for the various countries banks while the US Federal Reserve went as far as reducing the discount rate (the rate at which it lends to the commercial banks) which seemed to be the catalyst of the recovery rally.

One major concern still exists: The US consumer. The US consumer has been a major contributor to GDP although the majority of this was through spending and consumption (funded by debt and not savings). Credit has become tighter and the consumer is already struggling with their existing debt burden and so it seems unlikely that they will be able to contribute further to US GDP growth in the near term.

It is however becoming likely that the US Federal Reserve starts cutting rates at the September meeting. They have clearly stated that their key focus is to fight inflation. Inflation is in their range now (albeit at the top end) and they could potentially begin cutting now without loosing any credibility. What they don’t want to be seen as doing is cutting rates in order to protect bonuses on Wall Street.

The next pressing question is will a slow down in US consumption affect the Chinese and Indian growth stories. This is indeed hard to measure but in terms of Chinese exports the US only accounts for approximately 20% at present which gives us some comfort. The Shanghai composite once again astounded investors in August returning 16.7% (see chart above).

Markets are off to a reasonable start in September and seem to be consolidating their recent gains. It is quite likely we trade in a narrow range while uncertainty persists and market watchers await the Feds interest rate decision mid September. Historically September has not been a good month for US markets with the Dow averaging a loss of -1% over the last 57 years (see chart above courtesy of www.chartoftheday.com).

I do suspect that we have weathered the worst of the storm and hopefully we will have reasonably smooth sailing into the end of the year. Equity holdings were timeously reduced at the start of the month and provided we see a reduction in volatility we will consider increasing these in the comings weeks.