The Next Rally and Couple
of Weeks will Tell
Victor Hugo
Vega Asset Management
South Africa
May 29, 2006
What does one do when it feels like a crash but voices of reason
argue not to worry? It reminds me a bit of 1987 when economic
statistics and growth prospects and market values looked reasonable,
but suddenly markets turned down, despite expectation they would
be resilient. Initially, investors were concerned yes, but fairly
complacent and confident about recovery prospects - and were
buying -- just as now. I can almost hear my stockbroker of those
days saying "After all, there are no really good fundamental
reasons why this market should sell much further -- it's just
a correction in the bull market". The "won't sell much
further" became a crash when the markets dumped another
40% odd. After that investors had to be like Telkom -- please
be patient -- for recovery.
Come back to today. Doesn't all look relatively well in the US?
Their growth is OK - and it can be argued that surely they'll
make a plan to sort out the sky-high private property, corporate,
Federal, Social Security and national debt and trade deficit.
The US has done pretty well in the last few years and not much
of the public even realizes that Wall Street has been in a secular
[long-term] bear market since 1999 in inflation-adjusted terms.
The Fed's mighty package of lower taxes, lower interest rates
and a Middle East war to fuel the economy has managed to keep
the global economy on its feet after near collapse in 1998. And
bloated property prices with properties often more than 100%
bonded have meant that Mr. Consumer has always been able to dip
into the piggy bank even when fuel prices hurt. Asia and emerging
markets have benefited. Pretty respectable- looking growth of
3.5%+ constructed by the Fed and enthusiastically painted by
statisticians has made all look pretty OK. The reader may say
that they have heard all this before but that somehow the US
and Asia and emerging markets which sell to the US, are all happily
growing and in no mood to end the party. That's why G7, G8 and
G20 and G-plenty bankers keep supporting the US dollar, US Treasury
Bonds and US stocks. Okay, yes, one day, when they decide that
US paper and property will be cheaper later, there may well be
a race to disinvest. That's perhaps what global markets were
thinking as they bought gold, oil and commodities with enthusiastic
conviction during the last few years.
Then I look at all the research I read and the refrain is pretty
convincing -- this is merely a correction in the bull market.
They had better be right, because I was is quoted in Sunday Times
Money last Sunday under a heading "This is not the Crash."
It's always a bit worrying though, when too many people agree.
When in doubt, look at technicals and cycles relative to "the
fundamentals." Here the picture becomes a little less confident
yes -- the one- year trend for many of the indices and leading
shares is still up although shorter term trend evidence says
still lower next. Yet 2007 is a better candidate for a crash
according to the decennial cycle explained by Tom de Lange at
TASSA in January. The one-year trend and the longer- term cycle
also make me still prefer the correction in the bull market scenario.
But the next two weeks will be critical on momentum factors to
decide what the rest of the year will look like. Cycles can distort.
What the market does is more important than what clever people
like me think it will do.
The intensity of the selling in the last two weeks especially
on commodities could well be a warning that something more serious
is brewing. I put 19,500 on the JSE Overall Index as the key
support level to watch during the next two weeks or so. Accelerating
selling towards and through that level could well be an indicator
that the JSE is on its way to probe supports at 16,500 or an
intense scenario at about 13,000 during the next cyclically vulnerable
four months. I don't really think there is enough risk evidence
yet to justify long term investors to go fully defensive, but
as I have said before, some cash on hand to buy lower will be
useful. The market should work softer during the next few months.
The only debate is the intensity of the correction and whether
the evidence develops for a crash underway. For now, I'm reassured
by the fact that the R153 yield is behaving itself, the Rand
is showing little inclination to trend or stay above the key
ZAR$ 661 and 690 supports; the US$ is in long-term trend to weaker
with commodities stronger after short term shocks; these
factors should support the Rand good for SA; and global
behavioural factors are still more consistent with a correction
than a dump underway.
Watch this space carefully though. Things can change pretty quickly
and if you have a proactive approach to the markets and want
to make cash or position not to ride the market down too much,
you may have to be nimble and humble enough to accept change
when it comes. The next couple of weeks of momentum action and
macro behaviour will very likely tell.
For investors who are anxious to protect the gains of the last
two and three years, one possible strategy to apply, subject
to individual risk and goals and portfolio structure (get professional
advice if in doubt) - could be to monitor the markets carefully
during the rally underway. Evidence of dumping after the rally,
taking the JSE Overall Index quickly below 19,500 - could justify
switching say 50% out of a balanced unit trust or stock portfolio
to money market until the market bases, planning to accumulate
value later on in weakness or basing evidence. Although not a
trading strategy, the risk of this approach is that for whatever
reason, the market bases and you miss getting in again - and
incur costs. That's why most of the investment advice out there
prefers to buy and buy as the market falls, even though there
is risk of delay and underperformance after a correction or dump
or crash - e.g. 1997 to 2003 when many portfolios actually performed
negatively in absolute or inflation-adjusted terms. Remember
though that the portfolio managers in your favourite unit trusts
will also be doing their best to prevent undue drawdowns. They
also want to soften the effect of lousy markets when they come.
What about the commodities/resources sector? Until evidence
changes, I'm pretty convinced that this is a just a severe correction
in the major bull and that means that the Billitons, Anglo, Rio
Tinto, Kumba, Metorex, Northam, Schamin, Simmers, Sallies, Sasol,
AECI, Mittals - of the world - have to be bought on current and
any more weakness in the next three or four months. I'm expecting
gold shares soft until late July on cycles.
Financials: similar comment. Prefer the banks RMBH,
Standard, Investec for outperformance prospects. The current
weakness can still work lower, so don't be too anxious to load
up full weight now. Grayprop, Redefine and ApexHiB are beginning
to look interesting but again - - momentum suggests scope for
more setbacks before basing. Industrials: a subject on its own.
But for now I'm preferring defensives such as Astral, Netcare
and Aspen and will be a buyer of fixed development beneficiaries,
Telkom not MTN, retail, foods, Grindrod and Datatec in coming
months.
As always, currencies interest rates and the US are likely to
set up the first warnings of a correction turning into a crash.
Decide now whether to ride out whatever happens, or do some riding
and some proactive positioning. The answer will depend on individual
skills, appetites for risk -- and goals.
Whatever happens, there are getting to be a mix of disappointed
and pleased investors when everyone is wise with hindsight in
a few months time.
I'm working on the next Turning Point Newsletter due out next
Friday.
-Victor Hugo
South
Africa
Director: Vega Asset Management
email: analysis@hugocapital.com
website:
www.VegaCapital.co.za
Consultant to Hugo Capital.
P.S. we're working on the sites - but have a look at the new graphs
and analysis on www.HugoCapital.com
and www.VegaCapital.co.za
321gold Inc
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