Bull still in control
Current volatility on the JSE and elsewhere a healthy correction
THE MARKET CORRECTION that started in China this month and quickly spread to the rest of the world, especially after Wall Street responded with its biggest decline – measured in points – since March 2003, has resulted in a flood of reports and comment. What has crystallised is that the fright experienced by investors has more to do with the unwinding of the so-called “carry trade”, because of the cheap money available for so long in Japan, than with anything else.
The 9% fall on the Chinese stock exchange did send a shock wave through the world, but it was merely the trigger that sent nervous investors elsewhere scurrying. On the New York Stock Exchange, sell orders were so huge at one stage that the market could not process them all. Shanghai’s market is relatively illiquid and therefore tends to respond strongly to events. In contrast, Wall Street is the most liquid in the world, and its reaction is very important for the rest, including SA.
Large profits have been made for years, because market players borrow huge sums cheaply in Japan to invest them elsewhere at higher rates. That has contributed to the glut of international liquidity. SA has also experienced an inflow of many millions because the rand offers higher rates.
However, the dramatic strengthening of the yen wiped out the profits of many carry traders, causing them to literally fall over one another to reduce their risk exposure.
The turnaround in this trade could thus have important consequences. However, some commentators, such as Merrill Lynch Japan Securities’ chief economist Jesper Koll, say the “carry trade” out of Japan will continue, but in a new guise.
Koll says the balance sheets of Japanese companies are strengthening so much that they will increasingly be able to use their low interest rates and stronger yen to invest in assets elsewhere. Just the current correction on world markets already makes it cheaper for them to buy assets with loans in yen (the basic interest rate is only 0,5%).
But while the flood of liquidity out of Japan, the world’s second-largest economy, is getting so much attention, there’s some bad news from the world’s biggest player, the US – such as that an increasing number of home loans are starting to exceed the value of the underlying property. The feeling of prosperity from increasing house prices, along with easy and cheap new mortgage bonds, is something of the past. There’s also an increasing number of borrowers experiencing financial distress. This is likely to result in a substantial number of houses landing on the market in the next year or two. At the same time, there’s nearly eight months of stock that must be disposed of.
Another important factor is the latest profit projections for the Standard & Poor’s 500 index. This represents the 500 top companies in the US, and it’s expected that their profits in the last two quarters of this year will be less than in the corresponding period last year.
This is typical of the factors that herald the end of the upward leg of a cycle. The extent to which they influence sentiment on stock exchanges, especially Wall Street, will determine how far the correction will go. It
The fright experienced by investors has more to do with the unwinding of the so-called “carry trade”,
than with anything else.
seems unlikely at this stage that it will result in a bear market, though history shows that most people are unpleasantly surprised when the bear suddenly strikes.
The advice of Michael Zahorchak, former president of the international Foundation for the Study of Cycles, is not to rely on the forecasts of commentators. His research over a long period shows that technical aids such as moving averages are more reliable tools. For example, as long as a long-term average – he recommends 40 weeks – moves steadily upwards, it’s a bull market. The first warning comes when a short-term average – he found that five weeks works well – turns downwards. The market must then be watched carefully. If it falls through the mid-term average – he suggests 15 weeks – it’s an early warning sign. If both fall through 40 weeks, the warning lights are flashing. When the 40-week turns downwards, the bear has taken over.
His research also revealed that when the five-week rests on the 40-week, while the latter is still moving upwards, it can be regarded as a buying opportunity because it is likely to be only a correction. Measured in the above terms, the bull market is still intact in the US and also on the JSE.