Global (and in particular emerging) markets are currently in the throes of a necessary but painful breather. The relentless pace that saw most markets recover significantly from the lows of March 2003, with South Africa at one point up roughly 200%, was unsustainable, and the necessary correction therefore came as no surprise.
What did, however, come as a surprise, was the level of fear that it elicited. This has been surprising, given that a correction was certainly expected and predicted. Investors were even behaving prudently, with the unit-trust industry experiencing net outflows out of equity funds into asset allocation funds for the first quarter of 2006. Yet, in India, police were “keeping a watch near lakes and canals, possible places where people in distress could head to kill themselves”.
Granted, the Indian market fell roughly the same amount in one day as we fell in a month, but clearly certain Indian investors haven’t got the stomach for equity investments, and therefore shouldn’t be invested in equities at all.
The fact that the market had done 18% after four months meant that a correction was inevitable. So was that correction a brief breather for the bull before it starts snorting again, or have the bears finally come out of hibernation?
Let’s look at what is likely to happen:
- Earnings growth at 20% is expected from the JSE over the next 12 months.
- South African GDP growth of between 4% and 4,5% is expected.
- Rates are likely to ratchet up.
- The market is currently on a forward PE of less than 13, with a dividend yield of about 2%
- Our equity, growth and value funds are all on PEs of 10 or 11, with dividend yields of approximately 3,5%.
And let’s revisit the clouds on the horizon:
- Ben Bernanke, the new United States Fed head, has himself become a cloud, sending out confusing messages to the market. What is clear, however, is that he intends being tough on inflation, which has significantly increased the chance of a 17th rate hike in the US, to 5,25%. This will negatively affect the rand, emerging market assets and gold, while providing support for the dollar.
- The geopolitical environment seems to be slightly improved, with both the US and Iran talking, albeit not to each other at this stage. Hopefully dialogue can win over emotion in this particular instance.
- What were fully priced markets are now approaching more reasonably priced levels.
In summary, hang in there. Turbulence is never easy to stomach, no matter how strong your constitution. What is relevant, however, is your level of discomfort. If, like the Indians, you have been looking for a canal or a lake in order to end it all, then very simply, you are in the wrong product.
I have received numerous calls from journalists over the past month asking what investors should be doing now, and the answer is nothing. The whole point of portfolio diversification is that you start with an accurate assessment of your risk profile. You then choose a well-diversified portfolio of investments that allows you to sail through whatever conditions markets throw at you.
What you don’t do (which is unfortunately exactly what most people do) is to start changing sails in the middle of a storm. The risks involved in trying to switch in and out of markets based on fear are enormous! Markets have been stable and strong for long enough for investors to be properly diversified.
In addition, hopefully most investors have used recent rand strength to diversify offshore, and therefore the current turbulence, although uncomfortable, shouldn’t elicit too much pain.
Jeremy Gardiner is a director at Investec Asset Management