Bull still in con­trol

Cur­rent volatil­ity on the JSE and else­where a healthy cor­rec­tion

Finweek English Edition - - Creating wealth - LU­CAS DE LANGE

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.



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