Africa is widely perceived as poor and corrupt – hardly a great investment opportunity. But appearances can be deceptive, says Merryn Somerset Webb
How do you make real money? Most investors answer this in much the same way Warren Buffett does. They say that if you put your money into brilliant companies, brilliant sectors and brilliant countries, then hang on, you’ll end up rich. Global Thematic Investors (GTI) disagrees. When something is that good, most people know about it already and your purchasing price is going to reflect that, which will limit your returns even if things go as well as the market expects. And what if things don’t go as well as the market expects? Then your investment is going straight to “Money Heaven”.
Instead, say the analysts at GTI, the key to wealth is to make investments “where outcome exceeds consensus expectations”. If the consensus is that something is a basketcase and it turns out instead to be merely mildly mad, or even a recovery candidate, “it’s a sure-fire way to garner riches”. The more widespread the pessimism about an asset class, the more the odds are stacked in favour of “the early and the brave”.
This brings us neatly to Africa, about which it is hard to find anyone saying anything optimistic at all. In the developed world, the entire continent is considered to be little more than one big failed state. The papers this week alone have been full of Robert Mugabe’s £30,000 birthday party, the plight of child soldiers in the Congo, the Aids crisis in South Africa and the way in which the war in Sudan is spilling over into Chad. On top of all this, we know the region’s infrastructure is unsatisfactory, that its economies are blighted by widespread, extreme poverty and that its politics leave a lot to be desired. Africa is by almost all accounts a complete basketcase.
But look a little closer and you will see that there is more than misery here. In fact, if you take India and China out of the equation, sub-Saharan Africa is actually growing faster than Asia – which everyone thinks of as being packed with investible emerging markets. And as Patrick Collinson points out in The Guardian, the number of African nations seeing a decline in growth has fallen from 17 in 2003 to just six in 2006. Overall, the region is forecast to keep growing by at least 5% a year. There will be huge variations between countries, but the general direction is encouraging: much of Africa may be a shambles, but progress is being made.
Chinese direct investment in Africa
A great deal of this growth can be attributed to the new love-in between China and Africa. Earlier this year, China’s president Hu Jintao set off on an eight-nation tour through Africa, carrying with him the promise of $3bn in soft loans (all to come “without political conditions”) and a doubling of Chinese aid by 2009. It was just another step in the methodical courting of Africa by China: in the last 12 months, China’s top leaders have managed to visit a massive 48 African nations and last November 43 heads of African states visited Beijing. “We in China,” said Hu in one of his many long speeches, “take great pride in our friendship with the African people”. No doubt. But it isn’t just friendship China is after.
As we have often discussed in MoneyWeek in the past, China’s path from developing country to super-power needs to be paved with commodities. China needs Zambian copper, Nigerian oil, Tanzanian timber and South African platinum if it wants to keep its stellar growth rates going. It also needs food – it buys prawns and cashew nuts from Mozambique and oranges from South Africa, for example – which is why president Hu and his colleagues are so often to be found donning their lightweight blue suits and heading West. The result? Last year, trade between China and Africa soared 40% to a record $55.5bn. Direct investment has reached a cumulative $6.5bn, and at the November Forum alone 16 contracts between Chinese firms and African governments were signed. A third of Chinese oil now comes from Africa and it has recently agreed a $1.4bn deal to open new oil fields in Angola.
Benefits of Chinese investment in Africa
The many grants and soft loans that have paved the way for these deals are also bringing benefits. The Chinese have paid for a road-building programme around Ethiopia, including the “China-Ethiopia Friendship Road”, which rings the capital; they are financing the rebuilding of 100 schools and 30 hospitals in Liberia; they have cancelled $100m worth of loans to Cameroon; they have helped rebuild Angola’s once-famous Benguela railway; and they have set up a road-building programme in Mozambique.
None of this comes without its problems, but right now it seems the net effect is positive. When Hu talks about Chinese investment bringing “mutual benefit and win-win progress”, he is actually making a perfectly reasonable point. The arrival of the Chinese and their money has revitalised large parts of Africa and already huge areas of the continent have much better infrastructure than they did just a few years ago.
The key for Africa is to ensure it structures the deals it does with China so that they end up bringing some long-term benefits – in particular, this means investing the money strategically to help diversify economies away from their total dependence on natural resources. Africa has some time to figure out how best to do this – the commodities boom, and hence the seemingly unlimited supply of cash, should roll in for many years to come – and if it can get it right, many think it will mark a long-term turning point for the region. Using commodity growth to drive non-commodity growth, says Julian Ozanne of Uganda-based New Forests, represents “the best chance Africa is ever going to get to kick-start its own development”. China is, after all, the first “interested party of a significant size” to be willing to engage with Africa “without force of arms”, says Kobus van der Wath in the African Analyst.
African growth is about more than commodities
There is also a case to be made that African growth is not just about commodities. Chris Derkson of Investec tells Collinson the revival was underway long before the commodities supercycle really took off and points out that Kenya, buoyed by tourism and agriculture, is one of Africa’s fastest growers, despite having no commodities. And in Zambia, while copper exports are a boon, agricultural exports are also booming (in part thanks to the efforts of farmers chucked out of nextdoor Zimbabwe by Mugabe).
There are also already signs of a middle class emerging. In Nigeria, mobile-phone penetration is 8% and rising fast, while each user spends around $20 a month. According to analysts at Investec, events of the last ten years – the debt forgiveness that is giving nations a “fresh start”, the rise in successful democratic elections, the arrival of the commodity cash with which nations are paying off sovereign debt, and improving infrastructure – have all created a “momentum” that could now keep going even without the input of the commodities cycle.
Still, good news as this all is, the macro-environment is not the only reason to think Africa is a fantastic investment, says a recent GTI newsletter. There is also the fact that “African companies are some of the most profitable and fastest growing in the world”. Not convinced? Consider this: between 1995 and 2005 the stocks that make up the Blakeney index of African stocks showed compound annual growth of 22%. This might seem unlikely, but it does make sense, says GTI. The very factors most cite as reasons not to invest in Africa – political uncertainty, corruption and so on – have also created a group of winning firms.
Payback time has to be “lightning fast” to protect an investment from greedy kleptocrats and cash flow has to be self-generated, given how dysfunctional the banking system can be. The firms – often subsidiaries of the world’s leading multinationals – that have adapted to these circumstances have prospered and “mostly ended up monopolies or duopolies”.
However, the best news is that they are also often cheap in both absolute and relative terms. Often, p/es are half those of Western firms, despite higher growth rates, for example.
A final point to bear in mind is that it won’t take much money to get African’s exchanges moving. The total market cap of Ghana, Kenya, Mauritius, Zimbabwe and Uganda is not much more than $30m and much of that is illiquid – owned as it is by multinationals that have no intention of selling.
There are more companies coming – Derkson points to an expected round of privatisations in Kenya and Tanzania – but if much more foreign money turns up in Africa any time soon, or if the emerging middle class of Africa develops its own share-buying culture, we can expect to see markets move fast. This is already happening in Kenya, which has gone share-crazy in the last five years.
The local index has risen nearly 800% in dollar terms, and when KenGen, the state’s electricity firm, listed last year, the offer was three times oversubscribed and the shares quadrupled in the first day of trading. Nearly a million Kenyans now own shares.
Kenya isn’t the only African market to have risen recently – in 2006, markets in Botswana, Uganda, Tunisia, Nigeria and South Africa all rose well over 20% – but its extraordinary outperformance may be a sign of things to come elsewhere. With China’s investments being very well publicised and the World Cup hitting South Africa in 2010, Africa is likely to keep attracting attention.
Overall, as far as GTI is concerned, Africa is “outstanding value” and offers “the thematic investor” one of the best opportunities there is to make “multi-year, multi-bagger profits, rather like tech in 1990, oil in 1999, commodities in 2001 or Japan in 2003”.
One final reason to buy Africa: figures from Investec show that it is largely uncorrelated to other investment markets. So if you think trouble lies ahead for the booming markets in the rest of the world, you might like to start thinking of Africa in a new way: as something of a safe haven.
African investment: Where to put your money
Many of Africa’s shares look so cheap it is tempting to suggest having a go at buying individual shares listed on some of the separate exchanges. They have low p/es, high return on equity, and higher-than-average profit growth driven by fast-growing demand for goods and services. Nigeria’s biggest investment bank, IBTC, is on a p/e of six times and yields 9%; BAT Kenya, one of the region’s main cigarette manufacturers, is on a p/e of 11 times and yields 8%; while Zambia’s National Breweries is on 12 times and 8%. However, not only will this be verging on the impossible (it’s hard enough to find a UK broker that will let you buy individual shares in Japan, let alone Nigeria), but it also probably comes with more in the way of transaction costs and risk than most of us really need.
Unfortunately, the alternatives are limited. There is the Investec Africa Fund, whose managers are particularly keen on Tunisia, Nigeria and Egypt over the next two to three years. Roelof Horne, one of the managers (based in Africa), points out that the fund is not leveraged just to China or a resources boom, but “rather to the structural economic and political improvement that we are seeing in many countries across the African continent”.
I like this fund and the way it is managed (it has risen 60% since launch in November 2005) and I agree with its managers that “the opportunities in Africa have barely been tapped”, but I’m afraid it isn’t much good for most of us: the minimum investment is $1m.
Another possibility might be Botswana-based Imara African Opportunities Fund, launched in 2005 to allow international investors access to Africa’s emerging stockmarkets (it has limited exposure to South Africa and heavy weightings in Kenya, Zambia, Eqypt, and Nigeria, with an average p/e across its portfolio of about nine times). See Imaraholdings.com for more on the fund, but note it comes with a similar problem to the Investec fund: the minimum investment is $100,000. Finally, commodity funds give big exposure to the African mining sector.
JP Morgan’s Natural Resources Fund is one possibility.
The alternative is to invest in firms that do business in Africa: 40% of soap, pharma and white goods firm PZ Cussons’s sales come from Africa and Anglo American does a tenth of its business there. I have tipped PZ in the past and still like the look of it. It isn’t cheap any more on a p/e of over 20 times, but given its growth rate and exposure to Africa, it could be a long-term hold.
More speculative is Lonrho. This small Aim-listed firm (which recently changed its name from Lonrho Africa), with its annual revenues of a few million pounds, is all that remains of what was once the main vehicle for controversial tycoon Tiny Rowland’s many corporate manoeuvres and one of the biggest and most diversified firms in the world. But not for long. Its new boss, David Lenigas, has plans.
“We had revenues of $3m in February (2006) and we will have revenues of $300m by the end of 2007,” he told the FT. He intends to to rebuild Lonrho into the diversified conglomerate it once was (minus the deals with corrupt dictators and the feud with Mohammed Fayed). He may well manage it.
When he joined in 2005, Lonrho was down to £20m in cash, a stake in a hotel in Mozambique and one employee. Since then, Lenigas has been making deals left, right and centre. He’s got a controlling stake in Luba Freeport in Equatorial New Guinea, a 43% stake in South Africa-based Norse Air, a 49% stake in Kenyan discount airline Fly540 (you have to fly in Africa he says, “there aren’t any bloody roads”), a 10% stake in uranium producer Brinkley Mining and a 17% holding in South Africa-based Nare Diamonds.
He has also entered the African water sector via a holding in a Swiss firm and Lonrho intends to invest in natural resources and infrastructure, as well as branching out into luxury hotels and tourism. The shares have risen 25% in the last 12 months, but I think they are still worth buying.
Problems with African investment
Not everyone is happy with the way the Chinese have infiltrated Africa’s economies. The first problem to Western eyes is that no Chinese lenders follow the so-called “Equator Principles”. This is a voluntary code setting out social and environmental standards for financing projects in developing countries.
They aren’t always applied well, but they do act as a “barrier to projects that do more harm than good”, says the FT. Another worry is the flood of imports now finding their way from China to Africa – might local industry be swamped under cheap Chinese manufactured goods?
There is also concern that Chinese cash threatens the direction of development policy in Africa. The two main tenents of this are debt forgiveness and the linking of aid to better governance. But what use is forgiveness if China just lends Africa more money, setting off the cycle of dependence and failed repayments again? And why should corrupt regimes bother with reform if Chinese aid comes with no strings? Consider Zimbabwe. President Robert Mugabe’s birthday party this week took place against the backdrop of a ruined economy.
The price of bread is rising 100% a day; it takes a farmworker two months to earn enough to buy a bag of maize meal big enough to feed a family of six for a month. Unemployment is at 80% and many of those who aren’t, including all junior doctors, are on strike. Mugabe should be holding elections next year. He is extending his tenure instead. China is “right to invest in Africa”, says the FT, and its willingness to take risks means “it has a lot to offer”, but giving to the likes of Mugabe isn’t helping anyone: with Chinese aid on hand there’s no need for him to reform.
(MoneyWeek)
Tuesday, June 12, 2007
Stock market stability
Market action since the end of February has been lacklustre, particularly for the Dow, the words ‘dead’ and ‘cat’ come to mind when viewing the bounce. The next key technical support level for the Dow is 12000, if it does not hold, expect big sell-offs. We would not be surprised if there is some more bad stuff to come. So far, in percentage terms, major markets are not down a huge amount; the long overdue correction of at least 10% is still overdue.
Economist, Andrew Smithers, of Smithers & Co. Limited who quite recently estimated that the US stock market is 77% overvalued and the UK 68% overvalued, wrote in his World Market Update published on 28th February:
“In view of the overvaluation of stock markets, yesterday’s break could be the start of the second leg of the major bear market which started at the end of March 2000. The rising credit spreads in the corporate market, following the problems with the sub-prime mortgage market is a signal which would cause us most concern.”
Key threats to market stability
Credit spreads, the yield difference between the best quality bonds and the worst quality bonds, have widened a little; recently they were as narrow as they have ever been when J P Morgan’s High Yield Index was only 279 basis points above Treasuries. The increase so far has been to 323. At times of previous credit crunches, spreads have widened to 800, even 1000.
Two of the key threats to market stability are widening credit spreads and the rising value of the yen.
Widening spreads would impact considerably and put pressure upon the whole private equity business. Prices offered would have to fall to less attractive levels to compensate for increased debt servicing costs from rising corporate bond yields.
The “carry trade” would be severely damaged by a combination of a higher yen and lower assets prices. It is typically based upon borrowing yen and then investing in higher yielding non-yen assets with loads of gearing. Any rise in the yen would be a signal that the carry trade is probably unwinding, assets being sold to repay yen loans.
Another clue to developing conditions is provided by the stock market performance of companies such as Merrill Lynch and Goldman Sachs. These huge investment banks have, over recent years, profited massively from the liquidity driven financial business. If the market now perceives a slowing of such leveraged transactions, their share prices will be hit hard which, as you can see from the published chart of Merrill Lynch, is what has happened. Since its high in early 2007, Merrill Lynch’s share price has fallen almost 20%, indicating a current jaundiced market appraisal of their future earnings growth.
Other stock market indicators
Our Four Horses of the Financial Apocalypse have been snorting, whinnying and bucking. There is a real danger of them breaking into a wild uncontrollable gallop!
The white horse - false peace - The Volatility Index (VIX)
A sharp increase in volatility, but as yet not decisive. The previous VIX breakout occurred in May and June last year, the peak of that was 23.81. This recent breakout has so far peaked at 20.41. If this change is serious, then expect the VIX to head very much higher.
The unique economic conditions of global leverage, if unwound, could easily lead to a new all-time high being set for the VIX above 56.74. Fear has returned and suddenly the need for insurance is more important; except now insurance is a lot more expensive than it was only a week or two ago.
The red horse – war and destruction – The Philadelphia House Market Index
The US housing market news remains pretty grim. Sales of new homes in January fell by 16.6%, the biggest amount for thirteen years. House prices, year-on-year, fell 3.1%.
In the FT, Martin Wolf, recently wrote a piece headlined “Equities look overvalued, but where is the turning point?”
He identified some of the key dangers ahead:
• Markets will overreach themselves, so generating a destabilising correction (has this started?)
• Reduction in excess savings – outside the US and a tightening of the world interest rates (credit spreads have started to widen).
• Slowdown in US productivity growth (is already underway).
• A shift in global monetary conditions that threatens the soaring profitability of the US financial section (see Merrill Lynch chart).Of all the risks, he said that the biggest one is that the end of the US property boom will persuade US households to tighten their belts at last, thereby ending the US role as the world’s big spender before the big savers (Asia) are prepared to spend in turn.
Note: The words above in brackets are ours.
The sub-prime mortgage market goes from bad to worse, led by America’s second largest sub-prime mortgage provider, New Century Financial Corporation, whose share price has collapsed over 80% to 3.94. On 5th February it was 33.08.
The black horse – famine and unfair trade – Dow Theory
How quickly circumstances change. Two weeks ago we reported a very belated positive stock market confirmation using Dow Theory. The Transports had finally made a new high to confirm the new high achieved some months previously by the Industrials. Part of the theory does suggest that a long delayed confirmation is a weaker signal than a quick confirmation and this one certainly fell into that category.
The subsequent, simultaneous decline of both the Transports and the Industrials reverses the weaker positive signal into a new negative signal.
The pale horse – sickness and death – The Inverted Yield Curve
Where inverted yield curves exist in the US and the UK that situation has become more so rather than less so. The inverted yield curve is often an indicator of a future recession.
Alan Greenspan has recently spoken twice about the risk of a US recession this year. His latest statement said that there was a one-in-three likelihood. Merrill Lynch have economic models which suggest a 55% chance of a US recession this year. As we have said before, once a recession becomes official, which it does on two consecutive quarters of negative growth, the stock market should already have made its lows.
The probability therefore, is that this year, we are going to see much lower stock markets and that could happen quite soon if a US recession is to occur in before the end of this year.
On the other side of the coin, Hank Paulson, US Treasury Secretary and Ben Bernanke, Fed Chairman, have come out with market calming statements, but that’s no more than you would expect. Their job is to calm nerves not to stretch them.
We recently reported a modest purchase of Japanese stock market funds. These investments have weathered the storm quite well. Although the Japanese stock market has, like other markets, declined, the yen has appreciated so those new investments so far are under no threat.
The bear funds still being held have benefited.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
Economist, Andrew Smithers, of Smithers & Co. Limited who quite recently estimated that the US stock market is 77% overvalued and the UK 68% overvalued, wrote in his World Market Update published on 28th February:
“In view of the overvaluation of stock markets, yesterday’s break could be the start of the second leg of the major bear market which started at the end of March 2000. The rising credit spreads in the corporate market, following the problems with the sub-prime mortgage market is a signal which would cause us most concern.”
Key threats to market stability
Credit spreads, the yield difference between the best quality bonds and the worst quality bonds, have widened a little; recently they were as narrow as they have ever been when J P Morgan’s High Yield Index was only 279 basis points above Treasuries. The increase so far has been to 323. At times of previous credit crunches, spreads have widened to 800, even 1000.
Two of the key threats to market stability are widening credit spreads and the rising value of the yen.
Widening spreads would impact considerably and put pressure upon the whole private equity business. Prices offered would have to fall to less attractive levels to compensate for increased debt servicing costs from rising corporate bond yields.
The “carry trade” would be severely damaged by a combination of a higher yen and lower assets prices. It is typically based upon borrowing yen and then investing in higher yielding non-yen assets with loads of gearing. Any rise in the yen would be a signal that the carry trade is probably unwinding, assets being sold to repay yen loans.
Another clue to developing conditions is provided by the stock market performance of companies such as Merrill Lynch and Goldman Sachs. These huge investment banks have, over recent years, profited massively from the liquidity driven financial business. If the market now perceives a slowing of such leveraged transactions, their share prices will be hit hard which, as you can see from the published chart of Merrill Lynch, is what has happened. Since its high in early 2007, Merrill Lynch’s share price has fallen almost 20%, indicating a current jaundiced market appraisal of their future earnings growth.
Other stock market indicators
Our Four Horses of the Financial Apocalypse have been snorting, whinnying and bucking. There is a real danger of them breaking into a wild uncontrollable gallop!
The white horse - false peace - The Volatility Index (VIX)
A sharp increase in volatility, but as yet not decisive. The previous VIX breakout occurred in May and June last year, the peak of that was 23.81. This recent breakout has so far peaked at 20.41. If this change is serious, then expect the VIX to head very much higher.
The unique economic conditions of global leverage, if unwound, could easily lead to a new all-time high being set for the VIX above 56.74. Fear has returned and suddenly the need for insurance is more important; except now insurance is a lot more expensive than it was only a week or two ago.
The red horse – war and destruction – The Philadelphia House Market Index
The US housing market news remains pretty grim. Sales of new homes in January fell by 16.6%, the biggest amount for thirteen years. House prices, year-on-year, fell 3.1%.
In the FT, Martin Wolf, recently wrote a piece headlined “Equities look overvalued, but where is the turning point?”
He identified some of the key dangers ahead:
• Markets will overreach themselves, so generating a destabilising correction (has this started?)
• Reduction in excess savings – outside the US and a tightening of the world interest rates (credit spreads have started to widen).
• Slowdown in US productivity growth (is already underway).
• A shift in global monetary conditions that threatens the soaring profitability of the US financial section (see Merrill Lynch chart).Of all the risks, he said that the biggest one is that the end of the US property boom will persuade US households to tighten their belts at last, thereby ending the US role as the world’s big spender before the big savers (Asia) are prepared to spend in turn.
Note: The words above in brackets are ours.
The sub-prime mortgage market goes from bad to worse, led by America’s second largest sub-prime mortgage provider, New Century Financial Corporation, whose share price has collapsed over 80% to 3.94. On 5th February it was 33.08.
The black horse – famine and unfair trade – Dow Theory
How quickly circumstances change. Two weeks ago we reported a very belated positive stock market confirmation using Dow Theory. The Transports had finally made a new high to confirm the new high achieved some months previously by the Industrials. Part of the theory does suggest that a long delayed confirmation is a weaker signal than a quick confirmation and this one certainly fell into that category.
The subsequent, simultaneous decline of both the Transports and the Industrials reverses the weaker positive signal into a new negative signal.
The pale horse – sickness and death – The Inverted Yield Curve
Where inverted yield curves exist in the US and the UK that situation has become more so rather than less so. The inverted yield curve is often an indicator of a future recession.
Alan Greenspan has recently spoken twice about the risk of a US recession this year. His latest statement said that there was a one-in-three likelihood. Merrill Lynch have economic models which suggest a 55% chance of a US recession this year. As we have said before, once a recession becomes official, which it does on two consecutive quarters of negative growth, the stock market should already have made its lows.
The probability therefore, is that this year, we are going to see much lower stock markets and that could happen quite soon if a US recession is to occur in before the end of this year.
On the other side of the coin, Hank Paulson, US Treasury Secretary and Ben Bernanke, Fed Chairman, have come out with market calming statements, but that’s no more than you would expect. Their job is to calm nerves not to stretch them.
We recently reported a modest purchase of Japanese stock market funds. These investments have weathered the storm quite well. Although the Japanese stock market has, like other markets, declined, the yen has appreciated so those new investments so far are under no threat.
The bear funds still being held have benefited.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
Stock market rally last
The situation is that the stock market tops set in February remain secure. However, the markets, having fallen 7% (FTSE 100) and 8% (Dow Jones Industrials), are now enjoying a good rally. They have been helped this week by the latest Fed interest rate decision and the changes in their associated wording which point to a more likely easing than tightening. As the news was announced and the wording digested, so the Dow led markets higher, closing up 159 points on the day.
Why markets are destined for a correction
If stock markets have formed important tops, triggered by the US housing market slump and US sub-prime mortgage market woes, then they are destined to go much lower. In spite of the recent decline, it is still the case that a correction of at least 10% remains long overdue. We can but watch and wait for the market to deliver its decision. Either from below the February high, stock markets will turn over and test their recent lows (which for the Dow is 11940 and for the FTSE is 6000) or the recent rally from those very levels, will take stock markets higher and re-establish the bull trend.
Should markets recover and make new highs, we will consider closing the residual bear fund holdings and look to initiate small positions in one or two Asian markets, where the long-term future unquestionably lies. Alternatively, if, as we expect, stock markets head lower, the bear funds will do well and there will, almost certainly, be a very strong positive move by UK gilts.
The importance of the carry trade
The “carry trade”, which has been so important for stock markets, recently suffered a scary period as the yen rallied and put carry trade holdings under pressure – the carry trade is where investors borrow in a low interest rate currency, such as the yen, to invest in a high yielding currency, such as the New Zealand dollar – if the yen starts to rise, then those deals which are generally heavily geared will have to be sold. The yen, over the last two weeks, has given back some of its recent gains, bringing relief and renewed confidence to carry trade exponents. It is not likely that stock markets will do well if the yen returns to strength; for that reason, we are watching the Japanese yen/New Zealand dollar cross very closely.
Possibly by the time we write the next letter in two weeks, the market will have provided us with a clear message – we wait with baited breath.
What the stock market indicators are telling us now
Our Four Horses of the Financial Apocalypse were recently getting very boisterous but for the moment they feel reassured that the cause of their alarm, the sub-prime mortgage market, may have been overdone.
The white horse - false peace - The Volatility Index (VIX)
The VIX has pulled back to near its recent lows, having not reached the levels of June 2006. This renewed complacency would be shaken very quickly on any bad price action for assets.
The red horse – war and destruction – The Philadelphia House Market Index
No let-up on the grim news, the sub-prime mortgage market is in serious distress.
The resetting of the Adjustable Rate Mortgages that will be taking place this year and next year for mortgages set up last year, hangs over the market like the Sword of Damocles. Many US borrowers are going to face mortgage payments that are unaffordable, with no additional help available to them from the credit market. Large numbers of US sub-prime borrowers are probably financially doomed.
The 9% increase in US house building starts for February was a surprise, although it has to be borne in mind that this followed January’s grim 14% decline and a period of very bad weather. More important was the reported 2.5% decline in permits.
Donald Tomnitz, CEO at luxury house builder D R Horton, recently said “I don’t want to get too sophisticated here, but 2007 is going to suck, all twelve months of the calendar year.” And then Stuart Miller, CEO at Lennar Corp, said that they are writing off deposits and pre-acquisition costs for land it has under option. You don’t dump land if you are an optimistic house builder! Thanks to The Daily Reckoning for both of those recent quotes.
The black horse – famine and unfair trade – Dow Theory
This is the one that is going to carry the big message. The key lows and highs have been arrowed. If the coming price action takes prices below the arrowed lows for the Transports and the Industrials, then expect to see real problems for asset prices. Alternatively, if both arrowed highs are exceeded, markets might head higher quite quickly.
We think the levels we have highlighted are crucial. The good thing is they are quite close to current prices, so we should have a worthwhile signal soon.
The pale horse – sickness and death – The Inverted Yield Curve
This is the bogey-man – whilst the yield curve remains inverted, optimism must be low.
The fact that the Fed have just this week changed their tune and signalled easing rather than tightening is a clear indicator of their concern for the US economy - the danger really does lie to the downside. Lower US interest rates this year will most likely be because asset prices are falling dangerously and the Fed are desperate to put a floor under them. The inverted yield curve is predicting that will happen.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
Why markets are destined for a correction
If stock markets have formed important tops, triggered by the US housing market slump and US sub-prime mortgage market woes, then they are destined to go much lower. In spite of the recent decline, it is still the case that a correction of at least 10% remains long overdue. We can but watch and wait for the market to deliver its decision. Either from below the February high, stock markets will turn over and test their recent lows (which for the Dow is 11940 and for the FTSE is 6000) or the recent rally from those very levels, will take stock markets higher and re-establish the bull trend.
Should markets recover and make new highs, we will consider closing the residual bear fund holdings and look to initiate small positions in one or two Asian markets, where the long-term future unquestionably lies. Alternatively, if, as we expect, stock markets head lower, the bear funds will do well and there will, almost certainly, be a very strong positive move by UK gilts.
The importance of the carry trade
The “carry trade”, which has been so important for stock markets, recently suffered a scary period as the yen rallied and put carry trade holdings under pressure – the carry trade is where investors borrow in a low interest rate currency, such as the yen, to invest in a high yielding currency, such as the New Zealand dollar – if the yen starts to rise, then those deals which are generally heavily geared will have to be sold. The yen, over the last two weeks, has given back some of its recent gains, bringing relief and renewed confidence to carry trade exponents. It is not likely that stock markets will do well if the yen returns to strength; for that reason, we are watching the Japanese yen/New Zealand dollar cross very closely.
Possibly by the time we write the next letter in two weeks, the market will have provided us with a clear message – we wait with baited breath.
What the stock market indicators are telling us now
Our Four Horses of the Financial Apocalypse were recently getting very boisterous but for the moment they feel reassured that the cause of their alarm, the sub-prime mortgage market, may have been overdone.
The white horse - false peace - The Volatility Index (VIX)
The VIX has pulled back to near its recent lows, having not reached the levels of June 2006. This renewed complacency would be shaken very quickly on any bad price action for assets.
The red horse – war and destruction – The Philadelphia House Market Index
No let-up on the grim news, the sub-prime mortgage market is in serious distress.
The resetting of the Adjustable Rate Mortgages that will be taking place this year and next year for mortgages set up last year, hangs over the market like the Sword of Damocles. Many US borrowers are going to face mortgage payments that are unaffordable, with no additional help available to them from the credit market. Large numbers of US sub-prime borrowers are probably financially doomed.
The 9% increase in US house building starts for February was a surprise, although it has to be borne in mind that this followed January’s grim 14% decline and a period of very bad weather. More important was the reported 2.5% decline in permits.
Donald Tomnitz, CEO at luxury house builder D R Horton, recently said “I don’t want to get too sophisticated here, but 2007 is going to suck, all twelve months of the calendar year.” And then Stuart Miller, CEO at Lennar Corp, said that they are writing off deposits and pre-acquisition costs for land it has under option. You don’t dump land if you are an optimistic house builder! Thanks to The Daily Reckoning for both of those recent quotes.
The black horse – famine and unfair trade – Dow Theory
This is the one that is going to carry the big message. The key lows and highs have been arrowed. If the coming price action takes prices below the arrowed lows for the Transports and the Industrials, then expect to see real problems for asset prices. Alternatively, if both arrowed highs are exceeded, markets might head higher quite quickly.
We think the levels we have highlighted are crucial. The good thing is they are quite close to current prices, so we should have a worthwhile signal soon.
The pale horse – sickness and death – The Inverted Yield Curve
This is the bogey-man – whilst the yield curve remains inverted, optimism must be low.
The fact that the Fed have just this week changed their tune and signalled easing rather than tightening is a clear indicator of their concern for the US economy - the danger really does lie to the downside. Lower US interest rates this year will most likely be because asset prices are falling dangerously and the Fed are desperate to put a floor under them. The inverted yield curve is predicting that will happen.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
Financial meltdown
Investors need to wake up – we may be heading for a financial meltdown. So says Niall Ferguson, the Scottish professor of history at Harvard, who draws an ominous parallel between today’s markets and conditions prior to the financial collapse triggered by the outbreak of World War I in 1914. It was the “first great age of globalisation”, he says in Time.
Trade was expanding rapidly, growth was steady amid low inflation and interest rates, commodities were up, emerging markets were booming and volatility was historically low. “Sound familiar?”
Stock and bond markets barely budged when Archduke Franz Ferdinand was assassinated on 28 June. Only three weeks later, when Austria demanded access to Serbia to investigate alleged Serbian sponsorship of terrorists, did financial markets twig that war was not just possible, but certain.
The selling happened so suddenly, and on such a scale, that only by closing stock exchanges could a complete meltdown be avoided; the London exchange was shut until January 1915. It should have been clear to investors what damage war could do to stocks and bonds, but “it’s as if investors didn’t want to factor in [the likely war between Germany and Britain] until it was upon them”, Ferguson told Barron’s.
And just as the smart money of 1914 was blind to looming disaster, so the smart money of 2007 seems to have tuned out geopolitical risk. Ferguson points to buoyant stockmarkets, minuscule spreads between US Treasuries and junk and emerging market bonds, and the recent trend of declining volatility in stock, bond and foreign exchange markets as signs of complacency.
While a world war may be unlikely, a major conflict in the Middle East is a possibility, given the disintegration of Iraq and ongoing tension between Iran and the US. A withdrawal from Iraq by the US – today’s overstretched global policeman, a role Britain was playing in 1914 – could make the country as violent and unstable as central Africa in the 1990s, reckons Ferguson.
A geopolitical shock, such as conflict in the Middle East, could well cause such a liquidity crunch that stockmarkets would have to close. Investors today are as complacent as their great-grandfathers. “We might one day look back and say ‘God, the origins of the great Middle Eastern War of 2007 were very obvious’.”
(Moneyweek)
Trade was expanding rapidly, growth was steady amid low inflation and interest rates, commodities were up, emerging markets were booming and volatility was historically low. “Sound familiar?”
Stock and bond markets barely budged when Archduke Franz Ferdinand was assassinated on 28 June. Only three weeks later, when Austria demanded access to Serbia to investigate alleged Serbian sponsorship of terrorists, did financial markets twig that war was not just possible, but certain.
The selling happened so suddenly, and on such a scale, that only by closing stock exchanges could a complete meltdown be avoided; the London exchange was shut until January 1915. It should have been clear to investors what damage war could do to stocks and bonds, but “it’s as if investors didn’t want to factor in [the likely war between Germany and Britain] until it was upon them”, Ferguson told Barron’s.
And just as the smart money of 1914 was blind to looming disaster, so the smart money of 2007 seems to have tuned out geopolitical risk. Ferguson points to buoyant stockmarkets, minuscule spreads between US Treasuries and junk and emerging market bonds, and the recent trend of declining volatility in stock, bond and foreign exchange markets as signs of complacency.
While a world war may be unlikely, a major conflict in the Middle East is a possibility, given the disintegration of Iraq and ongoing tension between Iran and the US. A withdrawal from Iraq by the US – today’s overstretched global policeman, a role Britain was playing in 1914 – could make the country as violent and unstable as central Africa in the 1990s, reckons Ferguson.
A geopolitical shock, such as conflict in the Middle East, could well cause such a liquidity crunch that stockmarkets would have to close. Investors today are as complacent as their great-grandfathers. “We might one day look back and say ‘God, the origins of the great Middle Eastern War of 2007 were very obvious’.”
(Moneyweek)
Spring Of Top stockmarket trends
We've just hit another stock market milestone…
It began in March 2003 and has galloped all the way through to the present day. But to see and hear the way some traders, investors, and the blowhards on television have reacted recently, you'd think the world was coming to an end.
But when you take a moment to think about it, the truth is… a four-year bull market is a pretty good thing!
And that's exactly what we've had on the S&P 500. If you take a look at a chart of the index, dating back to March 2003, you'll see a strong bull market over that time, interspersed with five healthy corrections along the way. The longest pullback lasted about five months - from March 2004 to August 2004.
But right now, everyone is asking the same key questions: What does the recent market volatility mean? And is it the trigger point for another one of those "healthy corrections" - or something bigger?
Let's turn to the technicals for some clues about this stock market milestone…
US stock market trends: hangover from the seven-month party
When the market began rising in July 2006, not many people thought it would blast its way through to the end of February.
Most economists believed the correction (which began in May 2006) would cruise through the summer months into what are historically the weakest months of the year for the market - September and October. And especially given the markets traditionally experience a down cycle during mid-term elections.
But after bottoming out, the S&P 500 bulldozed into mid-October - and ended up exceeding its May 2006 highs, along with the Dow Industrials and Nasdaq indexes.
Capitalizing on increased liquidity from hedge funds and private equity funds, the overbought market continued to rise through the end of 2006 and into 2007. During this impressive 7-month rally, the Dow Industrials, Dow Transports, and all the small-cap indexes made new all-time highs.But the party couldn't last forever…
US stock market trends: the market started in February
A 9% slump in China's Shanghai Composite Index triggered a mass selling spree, with the ripple effect felt around the world.
In just three days, the Dow, S&P, and Nasdaq indexes gave back all their gains for the year. Since then, they've sprung back and forth between gains and losses.
So what next? There are two scenarios from here…
A Short Slip Or A Drawn-Out Decline?
There are three indexes that didn't toss all their gains away during the market's swoon: The Russell 2000… the S&P Small-Cap… and the S&P Mid-Cap. As I write, all three are clinging onto modest gains.
• Scenario #1: If they can stay above their 2007 lows, this correction could be short-lived.
• Scenario #2: If the small-cap indexes sink into negative territory for the year, we could be set
for a lengthy correction, or a consolidation period within a long-term bull market.
The upper blue line is drawn from the highs of March 2004, and you can see the highs from May 2006 touching it. The lower blue line is a trendline drawn off of the lows in March 2003. The red line represents the 200-day moving average.
As you can see, the S&P 500 blasted through the upper trading channel last October, before retreating back to test it just a couple of weeks later. The index then took off again, making a series of successive new highs.But when the market collapsed at the end of February, the S&P plunged back down to the top of the trendline.
This means we're now at a decision point...
Because the trendline has proved to be pretty solid support for the index since October 2006, it's possible that the bull market can resume from here. However, the February selloff inflicted a lot of technical damage, and there's probably more to go on the downside.
Stock Market Milestones: A Key 30-Point Support Range
Simply put, to confirm that the indexes have further to go on the downside, they first have to close below the lows posted during the brutal week of February 26 to March 2. That would put the S&P 500 back inside the trading channel - and then we'll be looking at the next area of support for a potential reversal.
But before we start thinking about that scenario, there's a key 30-point support range that you need to keep an eye on.
My colleague D.R. Barton, Jr. and I have written here about the proven predictive power of Fibonacci retracements. As a quick refresher, Leonardo Fibonacci was a 13th century Italian mathematician who popularized a string of inter-related numbers called the Fibonacci Sequence. In investment circles, this tool is used to gauge support (downside) and resistance (upside) levels where markets and stocks could head next. Following a major move, there are three main retracement areas - 38.2%… 50%… and 61.8%.
And once you identify these, it allows you to time your investments better, since you're able to pinpoint the best times to buy and sell.
So here's what Senor Fibonacci is telling us right now for the S&P 500…A 38% retracement from the July lows comes in at 1,370.The 50% retracement is at 1,341. And the 200-day (40 week) moving average is currently around 1,350, so we have a cluster of support within that 30-point range.
If the major indexes drop below their March 5 lows, the best case for the bulls would be for the S&P 500 to drop down into that range and consolidate for a few weeks before reversing to the upside again.
As I've shown on the chart above, the trendline coming off of the March 2003 lows moves up to 1,320 over the next few weeks. This is a critical technical level, as it represents about a 62% retracement off of the July 2006 lows.
• Bottom line: If the S&P tests that level, it must hold in order for the long-term bull market to stay intact. If the index drops below that mark, it would be bearish over the longer-term.
Stock market trends: we're heading higher - but beware volatility
However, with the Dow Industrials, Dow Transports and all the small-cap indexes having all notched up new all-time highs over the impressive 7-month market rally, my pattern recognition system has projected higher targets.
And although these stock market milestones have yet to be reached, my intermediate to longer-term analysis tells me that the February highs will eventually be taken out.
The key question is "when?" This answer is a little more uncertain right now - and with the market having found some real volatility for the first time in months, this is not the time to be pumping too much money into an unpredictable market. Keep some powder dry for now, and remain patient until we see some signs of a bottoming process.
(Moneyweek)
It began in March 2003 and has galloped all the way through to the present day. But to see and hear the way some traders, investors, and the blowhards on television have reacted recently, you'd think the world was coming to an end.
But when you take a moment to think about it, the truth is… a four-year bull market is a pretty good thing!
And that's exactly what we've had on the S&P 500. If you take a look at a chart of the index, dating back to March 2003, you'll see a strong bull market over that time, interspersed with five healthy corrections along the way. The longest pullback lasted about five months - from March 2004 to August 2004.
But right now, everyone is asking the same key questions: What does the recent market volatility mean? And is it the trigger point for another one of those "healthy corrections" - or something bigger?
Let's turn to the technicals for some clues about this stock market milestone…
US stock market trends: hangover from the seven-month party
When the market began rising in July 2006, not many people thought it would blast its way through to the end of February.
Most economists believed the correction (which began in May 2006) would cruise through the summer months into what are historically the weakest months of the year for the market - September and October. And especially given the markets traditionally experience a down cycle during mid-term elections.
But after bottoming out, the S&P 500 bulldozed into mid-October - and ended up exceeding its May 2006 highs, along with the Dow Industrials and Nasdaq indexes.
Capitalizing on increased liquidity from hedge funds and private equity funds, the overbought market continued to rise through the end of 2006 and into 2007. During this impressive 7-month rally, the Dow Industrials, Dow Transports, and all the small-cap indexes made new all-time highs.But the party couldn't last forever…
US stock market trends: the market started in February
A 9% slump in China's Shanghai Composite Index triggered a mass selling spree, with the ripple effect felt around the world.
In just three days, the Dow, S&P, and Nasdaq indexes gave back all their gains for the year. Since then, they've sprung back and forth between gains and losses.
So what next? There are two scenarios from here…
A Short Slip Or A Drawn-Out Decline?
There are three indexes that didn't toss all their gains away during the market's swoon: The Russell 2000… the S&P Small-Cap… and the S&P Mid-Cap. As I write, all three are clinging onto modest gains.
• Scenario #1: If they can stay above their 2007 lows, this correction could be short-lived.
• Scenario #2: If the small-cap indexes sink into negative territory for the year, we could be set
for a lengthy correction, or a consolidation period within a long-term bull market.
The upper blue line is drawn from the highs of March 2004, and you can see the highs from May 2006 touching it. The lower blue line is a trendline drawn off of the lows in March 2003. The red line represents the 200-day moving average.
As you can see, the S&P 500 blasted through the upper trading channel last October, before retreating back to test it just a couple of weeks later. The index then took off again, making a series of successive new highs.But when the market collapsed at the end of February, the S&P plunged back down to the top of the trendline.
This means we're now at a decision point...
Because the trendline has proved to be pretty solid support for the index since October 2006, it's possible that the bull market can resume from here. However, the February selloff inflicted a lot of technical damage, and there's probably more to go on the downside.
Stock Market Milestones: A Key 30-Point Support Range
Simply put, to confirm that the indexes have further to go on the downside, they first have to close below the lows posted during the brutal week of February 26 to March 2. That would put the S&P 500 back inside the trading channel - and then we'll be looking at the next area of support for a potential reversal.
But before we start thinking about that scenario, there's a key 30-point support range that you need to keep an eye on.
My colleague D.R. Barton, Jr. and I have written here about the proven predictive power of Fibonacci retracements. As a quick refresher, Leonardo Fibonacci was a 13th century Italian mathematician who popularized a string of inter-related numbers called the Fibonacci Sequence. In investment circles, this tool is used to gauge support (downside) and resistance (upside) levels where markets and stocks could head next. Following a major move, there are three main retracement areas - 38.2%… 50%… and 61.8%.
And once you identify these, it allows you to time your investments better, since you're able to pinpoint the best times to buy and sell.
So here's what Senor Fibonacci is telling us right now for the S&P 500…A 38% retracement from the July lows comes in at 1,370.The 50% retracement is at 1,341. And the 200-day (40 week) moving average is currently around 1,350, so we have a cluster of support within that 30-point range.
If the major indexes drop below their March 5 lows, the best case for the bulls would be for the S&P 500 to drop down into that range and consolidate for a few weeks before reversing to the upside again.
As I've shown on the chart above, the trendline coming off of the March 2003 lows moves up to 1,320 over the next few weeks. This is a critical technical level, as it represents about a 62% retracement off of the July 2006 lows.
• Bottom line: If the S&P tests that level, it must hold in order for the long-term bull market to stay intact. If the index drops below that mark, it would be bearish over the longer-term.
Stock market trends: we're heading higher - but beware volatility
However, with the Dow Industrials, Dow Transports and all the small-cap indexes having all notched up new all-time highs over the impressive 7-month market rally, my pattern recognition system has projected higher targets.
And although these stock market milestones have yet to be reached, my intermediate to longer-term analysis tells me that the February highs will eventually be taken out.
The key question is "when?" This answer is a little more uncertain right now - and with the market having found some real volatility for the first time in months, this is not the time to be pumping too much money into an unpredictable market. Keep some powder dry for now, and remain patient until we see some signs of a bottoming process.
(Moneyweek)
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