Why Worry....?
Victor Hugo
World markets are drifting but generally sitting pretty okay if one looks at mood. Risks of confidence shifts are always there, but for now the world seems to think that all is well.
Market watchers know though that all is not well and that the US is sitting on a time bomb of debt and the risk of domino collapses of Wall Street prices, bonds, property and the US$. A scenario that can accelerate if the world community - whatever the reason -- decides that its investment returns will do better elsewhere than in US assets.
The US has some huge structural problems. These need to be remembered when planning market strategy:
- The US is no longer the industrial engine that fuelled it to become a superpower.
- For several years the US has actively created money by spending and borrowing money to record debt levels - national, federal and private debt that is now so big that crisis or inflation is needed to unravel the bird's nest.
- Thirdly -- the US has become more vulnerable to higher energy prices. Consumption has increased every year since peak of oil production in 1970. The oil and natural gas supply is limited. Costs of using more of what is left are increasing. (Have a look at an interesting article in the June National Geographic - "The End of Cheap Oil" ).
Much of the world resents the US's military, financial and technological muscle and has forgotten that it owes its growth in the last 60 years to the relative peace to which the US has been the major contributor, warts and all. The response from the US to the resentment is increasing protectionism, isolationism and attempts to control. Not a happy environment to promote the growth that the US and global economy so importantly needs. The war against terrorism is a costly affair and the US needs all the friends it can have.
Some cycle evidence suggests seasonal vulnerability for Wall Street and major markets in Q3 2004.
The US is a technological powerhouse, innovation powerhouse, services powerhouse -- yes. But often not as cost- effectively as Asia these days. There will never be a world power that can indefinitely rely on debt and consumption spending to grow and flourish.
In the last three years, US stimulatory measures have fuelled consumption increases that have fuelled enough illusion of economic robustness to make all look okay and to delay the time of reckoning. Enough illusion of growth to make magician Harry Houdini look like a wizard.
US interest rates have to increase to begin dealing with the debt burden. But rates cannot go up too fast, without bringing down the asset price structure now balanced on dominoes or on a thin and very inflated bubble.
The Fed, with the support of investors all over the world who have built trust in the US- dominated system for decades -- hope to buy enough time to keep constructing a soft landing recession and non-painful adjustment -- instead of the type of long, hard landing the Japanese had to go through for years ( in their case since 1989) or what the world went through during the course and aftermath of the World Wars.
Problem is that the real problem is not being confronted.
The US has to consume less without growing less. How?
No answer to that. If there were - solutions tackling would already have started much more aggressively. This is why the US$ is trending weaker and classes such as commodities and precious metals are buoyant. Depending on where you watch from -- these classes thrive on currency uncertainty and inflationary and dis-inflationary risk scenarios. The market understands that in the next few years, the US is not going to be able to keep consuming the world's goods and services at the same rate. Although China and others are growing, global consumption from Asia is nothing like enough to keep the global growth ball in the air.
History shows that when a major power has to adjust economically - it resorts to stimulation and if that fails - it resorts to war. Let us trust that the world is wiser than before and we don't have to repeat that behaviour.
Then also as we consider Market Strategy, let's remember that wonderful South African saying - "Why worry, be happy - tomorrow is another day..." - suggesting that it is important to rather focus on the positives - problems will work out in time -- and along the way life goes on. Problems do work out. How gracefully or painfully the world does it this time, will be watched on the TV "History " programs a decade from now.
JSE Positives
Focusing on the positives though -- let's look at the unique position of the South African JSE. In a resource rich country where the mood is less worried about the world's problems than getting on and building a flourishing economy. A growing middle class. Interest rates in long term technical downtrend (and probably fundamentally as well). South Africa's currency - the Rand - increasing in value relative to both the US$ and the Euro. Property market booming. Attracting increasing foreign investment. An already powerful infrastructure and mines - built mainly in the last century with the leadership and capital of those awful colonialists from Europe. However they were good engineers. More Infrastructure development being planned or underway. A stable, peaceful nation looking for growth of wealth - not destruction of wealth. Not addressing social problems fast enough - but no country is! A country that says we don't want to lose Rule of Law like Zimbabwe did - a gift from that previous breadbasket of Africa.
Okay - not all roses - but just enough critical positive mass to facilitate improvement and sustainable growth. Some economists will agree that it only takes 4% of a country to be optimistic to turn the national mood. A big turnaround from the despair of recent years. Now we even hear of retired folk wanting to borrow and buy in the booming property market! I hope they remember that interest rates eventually turn.
For now though, long- term interest rate indicators such as the R157 government Gilt, last week again showed technical buy signals -- suggesting scope for still lower or at least sideways interest rates in perhaps a two- year cycle to come. Our interest rate differential with the West and First World in the East -- is still supportive for lower rates and some more property boom for a couple of years. I don't think we are at bubble levels yet. When property pop comes e.g. in the US and in the UK - SA will also feel a shortage of tenants forcing some overextended owners to sell forcing a dip in property prices. But my guess is SA property has enough supportive basics in place to be pretty resilient.
So what does one do with one's capital invested or about to be invested in the JSE? Firstly does one invest in the JSE when at every Sunday barbecue you hear from friends how you should be in property - not the JSE. Answer is that for the first time in years - the JSE has scope to confirm a buy- and- hold bullish environment to reward medium- and long- term investors.
Since 1998 we have been in a market timing environment. In contrast to the period e.g. 1982 to 1998 which was a buy- and- hold long-term bull market.
Problem is that the JSE is not yet quite confirming the beginning of that new long-term bull market. Will it begin from current levels, basically a bit lower than now (as the stronger Rand puts some pressure on the JSE)? Long-term interest rates are signalling that they have scope to come down further - usually good for markets. Or will the best buying opportunity be after Wall Street and other major markets do their collapse or a shakeout?
No- one really knows the answer -- but as investors, we have to take a view. Investors can do sums to estimate what companies will earn in the next year and three years -- but that doesn't deal with contingencies and market mood shifts. I suggest that in both value and market timing environments - it is useful to use what I call Relativity Analysis - combining the benefits of earnings analysis with technical and cycle analysis.
That way one can take into account e.g. several months of phases of market confidence or fear and can build a strategy to be defensive and protect capital. After a Wall Street or global market selloff - the decisions for JSE investors to buy in perhaps big dips -- will be so much easier than now. But the risk of missing out in case a global sell-off doesn't come -- is also there.
This means that we have to invest -- and it means taking a view on sector classes and asset allocation which way next - including how much cash to keep available.
I would also suggest that if market vulnerability signals loudly, one has to be positioned so as through diversification, hedging or switching into money market -- to be able to protect one's investments, accumulating the down phases. A defensive approach also applies to life policies, retirement annuities, endowment policies, pension schemes, unit trust savings -- all linked to the JSE, many of which enable cost-effective switching in order to avoid having to ride a lengthy bear market down and ability to switch again when sentiment is most negative and value is at good levels.
JSE Sector Groups.
Not the space to go into in detail here -- but give some thought as to the likelihood of which asset classes and JSE sector groups will perform in the next year or two. Financials, Industrials, Resources, Gilts ( bonds), Property, Money Market. Which shares will do best should interest rates go down as we expect? You don't want to invest in exporters if you agree that the Rand is going stronger. You don't want to invest in the Property sector if you believe that the SA Property sector is near a bubble pop! And vice versa.
How about Resources? Yes, could be some useful buys here now that they are down on March's levels. Find the value and those that will do okay despite scope for a still stronger Rand. It needs taking a view on the Rand and on demand from outside of the country as well.
You do want to invest in special situation and heavy diversified Industrials - companies who are well- positioned to take advantage of growth opportunities and well-managed risk.
Speak to a financial adviser who can assist you with asset allocation and investment selection according to your goals and risk profile.
What do we think? We'll be looking for JSE investment situations that are going to do well with the Rand in the zone 4.80 to 6.50 during the next two years. In companies that will do well in a lower interest rate environment when at value levels e.g. Financials and Property -- although would urge in these sector groups to have some cash available to buy major dips in coming months.
Overweight in special and heavy diversified situations with value - in Industrials. For instance I am watching the IT sector and JSE Construction and Building Materials sectors and Retail for buy signals.
Would look to use normal weighting on Resources - now that they have dipped, although this sector may still battle lower for a while until perceptions grow that the Rand has found its strongest levels (for instance when the Rand reaches $ZAR 5.80 area, there is a big technical resistance). China and Japan are not about to stop demand - and there is a lot happening locally as well. A Gold and Platinum run is always on the horizon as well.
Would look to be buying Gilts now.
Gold shares are at value levels with $Gold firm.
Accumulate, keeping an eye on the Rand and US$ as well.
Victor Hugo
www.HugoCapital.com
www.SAgolds.com
www.GoldSignals.com
1 July 2004
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