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Friday, February 1, 2008
Of dead cats, pink elephants and giraffes

They say an elephant never forgets, yet humans seem to have short term memories, at least when it comes to things like investments. And, as if seeing pink elephants, we seem to delude ourselves through sentiment.

It is difficult to work out what’s going on in global markets, not because we don’t understand investment principles, economic indicators, or the concepts of supply and demand, but because we don’t understand ourselves — our emotions. Why do people sell their shares before the market goes up? Or why do they buy them before the market goes down? No one has ever really ever figured that one out, other than to put it down to sentiment and short term memory.
Of course, investing is a zero-sum game: the shares were issued by businesses years ago, some I dare say over a hundred years ago. These businesses have had the money — they just need to husband it properly to influence ‘sentiment’ in the market-place in a positive way. If their share price goes up then the investors (including directors and, hopefully, the employees) will benefit. The company may also go to the market for further capital if it proves itself with a good track record.
But the real point is that if one person sells some shares another person buys them: one gains, one loses. If the market is continually going up, then the seller may be consolidating a profit, while the buyer will still enjoy some future profit. But he has still lost out on the previous wad of profit — only one person can benefit at a time. For one person (company, asset management business or whatever) to make a lot of money then a lot of individuals each have to lose a bit.
A person’s decision, say, to sell shares is determined by his view of the market. His view will be different to the view of the person who decides to buy those shares. Decisions, views, reasons, expectations, all amount to sentiment. This may all seem very obvious, but it is significant that the people who have made the most money out of investing in shares have very often done so by going against prevailing sentiment of the day. Included in our clutch of stories accompanying this lead article is one that explains the ‘contrarian view’ — which would mean currently that we should hold our equities, even buy more.
One further aspect is that big investors, especially institutional ones, global players, asset managers and so on will rarely tell you which shares to buy before they’ve bought them. Why should they? They do not want to put the price up before they buy. Instead they will tell you where they think the market is going and what counters are a good bet. They are telling you what their take is on the situation, but don’t forget that they have already taken the action they are promoting. All you are going to do, if you follow their advice, is to support their pricing ambitions.
Underlying all of this, of course, is the long term rate of inflation. Because whatever rands you put into the market you have to exceed rising prices at the very least to justify holding equities.

Bit of confusion

Right now, it is not really possible to analyse the situation sensibly. The global markets seem to be in a bit of confusion. We have the rand going down while SA’s interest rates have been going up; the US dollar is strengthening, although that country’s interest rates are being eased down. Strange, isn’t it, that higher interest rates do not attract more deposits (which would ordinarily increase demand and therefore the value of your currency)?
Gold has touched an all-time high of US$933.90, which is supposed to be good for South Africa. Yet our stock market plunged 20% from a peak of 31 531 (early October 2007) to a trough of 25 135 towards the end of this January.
Not surprisingly, amid fears of US recession and the electricity cuts in SA, foreign selling of SA shares spiked sharply last month, resulting in a net outflow of R9 billion, the highest single monthly outflow on record – all because of sentiment.
The JSE All Share index has since recovered to almost 29 000, and gurus are pondering whether this is the so-called ‘dead-cat’ bounce. This usually occurs in a market set on a long term plunge (a bear market), but that in its death throes it sort of bounces up along the way. Perhaps we should move away from such ghastly imagery, as we may read further on how global market volatility is being well managed.

US trade deficit

Meanwhile, why is the US dollar relatively firm? The country’s trade deficit is running at about $68 800 million a month, and has been rising for the last 30 years, during which time this state of affairs should have caused a serious international crisis. In January 2003 it was running at $41 billion a month, and yet nothing adverse happened to the US currency. Bear in mind the monthly figure is not the total deficit, but the increase in deficit for that month. It’s totally crazy.
As of mid-June 2007 the gross US external debt stood at $12 trillion. The net international investment position (NIIP), after accounting for US assets abroad, amounted to $2 539,6 billion (that was about $2,5 trillion) by the end of 2006, having deteriorated continually since 1986.
Economists, investment gurus and other ‘experts’ have been agonising over the NIIP for years, predicting a global meltdown. Pure logic would suggest it cannot go on forever. If the US economy does eventually collapse it will probably bring its major trade partners down with it. That would be Canada (accounting for 17% of total US imports), China (16%), Mexico (11%), Japan (8%), and Germany (5%).
But remember our measly total $23 billion odd external debt in the late eighties? It was a major influence in the deterioration of the rand from 1981 when it was around parity to the dollar, to where it is today – about a seven-fold loss in value (although it had been a lot worse).
Even last month the rand went down (again) 8,7% since the beginning of the year to around R7,64. Economists say the reason is that we need around R10 billion capital a month to cover our current account deficit so, ‘It is not surprising that the rand has depreciated.’
Really? So what about the US then, which needs about $2,3 billion a day to achieve the same thing?!
It does not really make sense. But then it does not have to make sense because sentiment, which is really driving all this, is not something you can explain. Indeed, the last thing you should do is obey Obi-Wan Kenobi who admonished, “Trust your feelings, Luke.”
Instead, please read the following articles that lay down some important principles. We need to focus on long term investing, while diversification is still the best strategy whether markets are going up or going down. Our investment sages remark that ‘we are in for a bumpy ride’ but they remain bullish on equities for the long term. There is the huge increase in capital expenditure on infrastructure in SA and the positive sentiment (!!) associated with the 2010 World Soccer Cup bun fight.

Volatility in SA

This is despite South Africa suffering both external, as well as internal disruptive influences. CPIX inflation rose further to an annual rate of 8.6% years-on-year in December, from 7.9% in November. SA Producer Inflation also increased to 10,3%, from 9,1% the same period. Our fuel is rising another 17 cents a litre 6th February to R7,64. It went up 47 cents last December. Cost pressures are also working through from rents, wages and materials, while there is the latest threat of higher electricity prices with the aim of encouraging rationing.
Eskom’s debacle has added to global jitters over supplies. We now have the prospect of mines being unable to extract coal and refineries unable to produce fuel because of the unreliable electricity supply. This, in turn, will disrupt Eskom’s power supplies, and make it more difficult for shopping centres to install alternative power generators that use diesel. One can only wonder if the vicious cycle could get any worse.
Incidentally, the criticism that Eskom exports up to 5% of its power (1600 MW) to neighbouring countries may be misplaced. After all it has contractual obligations and, besides, we have a vested interest in maintaining cross-border power infrastructure.
Which may lead us to a final point on sentiment. No matter how ‘sophisticated’ South Africa’s infrastructure, now matter how vibrant, varied and colourful its economy, it is still tainted with the world’s pre-Victorian view of the continent. Unrest in Chad, the devastating economic meltdown in Zimbabwe, and the serious Kenyan political violence, following the alleged rigged elections in December, only serve to feed that prejudice.
How is anyone supposed to handle a question like this: “Do you still have giraffes on the roads?” It was asked recently of a South African music student attending college in Sweden. And this has just reminded me of an old, but true story from the diplomatic circles of Washington. An American official swallowed hook, line and sinker, the description of how we have an extra blue light in our traffic signals. So when the lights turn blue all cars have to stop for the elephants.
So forget reality; it’s all down to sentiment. Ignoring it is a good investment strategy. By Nigel Benetton

Copyright © Insurance Times and Investments® Vol:21.1 1st February, 2008
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