Rally run ning out of steam

Re­sist the buy but­ton and take some money off the ta­ble

Finweek English Edition - - Cover - BY VIC DE KLERK

TLis­ten to the pod­cast on Fin24.com HE WORLD­WIDE IN­CREASE – call it a par­tial rally – in share prices that took off in earnest in the sec­ond week of May is beginning to run out of steam. Cracks are start­ing to show in the out­spo­ken self-con­fi­dence that pushed up the Stan­dard & Poor’s 500, the best mea­sure of share prices in the United States, by 40% since March.

June has sud­denly be­come a hard month; the past week even more so. The S&P 500 has bogged down, even fall­ing by al­most 5% in June.

In­vestors in South Africa have to learn how to live with the cur­rent poor per­for­mance of share prices on the JSE. And re­mem­ber: the tra­di­tion­ally lack­lus­tre third quar­ter – when share prices sel­dom in­crease and usu­ally reach a low some­where in Septem­ber – is still to come.

The spark that caused share prices to ex­plode in the US in March ig­nited all share mar­kets world­wide, and par­tic­u­larly those in emerg­ing mar­kets started leav­ing real un­der­ly­ing value far be­hind. Com­men­ta­tors on Bloomberg are warn­ing about a new bub­ble that could burst, es­pe­cially in the prices of smaller com­pa­nies in the Asia re­gion. Things are pro­ceed­ing so mer­rily there now that the MSCI’s Asia in­dex is al­ready trad­ing at an earn­ings mul­ti­ple of 42. That’s more than twice the level at year-end 2008.

The Stoxx 600, Europe’s com­pre­hen­sive in­dex, is trad­ing at a PE of 24, nearly the same as the high­est level reached in 2004, largely be­cause the profit of the com­pa­nies in­cluded in the in­dex has fallen by 47% over the lat­est quar­ter. It’s dif­fi­cult to jus­tify the si­mul­ta­ne­ous in­crease of 31% in the value of the in­dex.

The PE of the US’s S&P500 is cur­rently 62, while Bri­tain’s FTSE in­dex is an alarm­ing 84 (see box for an ex­pla­na­tion of those ab­surdly high PEs).

In­vestors and spec­u­la­tors clearly re­alised early in March that the US, and es­pe­cially Bri­tain and Europe, weren’t go­ing to go bank­rupt, not yet at any rate. The tril­lions pumped into the fi­nan­cial sys­tem by the three ma­jor play­ers pushed in­ter­est rates down to nearly zero. In fact, the rate on 90-day US Trea­sury bills was at times even neg­a­tive. The ex­cess liq­uid­ity had to spill over to other fi­nan­cial as­sets. One of those was shares. Emerg­ing coun­tries’ cur­ren­cies also at­tracted at­ten­tion. But there was so much money that even US shares were pop­u­lar.

But it looks as if things are start­ing to cool down a bit. For a start, the fall in in­ter­est rates – es­pe­cially those on long-term US Gov­ern­ment bonds – has sud­denly been halted and has turned around in earnest. In­ter­est rates are ris­ing again, which is never good for share prices.

The enor­mous de­cline in eco­nomic ac­tiv­ity – es­pe­cially in­dus­trial pro­duc­tion, which in the huge euro area was more than 20% lower in April this year than in the pre­vi­ous year – her­alds a sober­ing mood and the re­al­i­sa­tion that the credit cri­sis harmed eco­nomic growth much more than was ini­tially be­lieved. Com­pany prof­its have been brought sharply down, partly due to the new IFRS and the re­quire­ment that the value of fi­nan­cial in­stru­ments in pos­ses­sion must be writ­ten off as the mar­ket pre­scribes.

In SA, share prices are also run­ning away rather too quickly. Re­mem­ber that all four of SA’s Big Four com­mer­cial banks have al­ready warned that their prof­its for this year will be lower than last year’s. And that’s with in­ter­est rates be­ing low­ered.

Along with the on­go­ing weaker prices of many com­modi­ties, man­u­fac­tur­ing, at 22% lower than a year ago, and re­tail sales in April, with its many hol­i­days and buy­ing op­por­tu­ni­ties, still 6,7% lower than last year, there are enough warn­ings in SA that a pause in the sharp in­crease in share prices is now nec­es­sary.

http://www.fin24.com/ mul­ti­me­dia/pod­casts.aspx

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