Equity markets have bounced off the January lows, but what now?

THE year 2008 started with a bang. No sooner had we returned from holidays than we were met with heightened fears of a rapidly slowing global economy and a continuation of bad debt worries stemming from the global banking sector credit crisis.

Equity markets fell rapidly, seriously shaking the confidence of the investing public that had become complacent after four consecutive years of excellent inflation beating returns. Conventional wisdom from a number of market commentators was that it was time to batten the hatches, sell some of your equity portfolio and accept the inevitability of a mini bear market.The only question was how long the sell-off was going to last, with the bears arguing that we are in for a year or two of depressing returns.To an extent however, we at Investec argued publicly exactly the opposite.The speed of the sell-off in January was vicious, giving little opportunity to make any serious adjustments to one’s equity exposure.MARKET FEAR It was in this post-sell-off period in middle January that we considered that the market fear was so great that at the very least we would get a short-term upwards bounce from such an oversold position.And aside from that, the medium-term prospects did not look as bleak to us as to avoid the opportunity to buy high quality listed companies at bargain basement prices.Well that is all water under the bridge, in that markets have indeed bounced back over the past couple of weeks.The real question is what now? Do we congratulate ourselves on not panicking a while back and now use the modestly recovered share prices to sell, or do we hang in there for the long haul? Well, there are no guarantees, but in short we would hang in there and hold your shares.In many instances after we have sold we forget to buy the shares back as we wait for even better re-entry levels, but more importantly, over time on average shares have delivered returns approximately seven percent ahead of cash per annum.To earn this famed “equity risk premium” one needs to be invested in equity over time, and be prepared to suffer the heart failure that setbacks like the recent one periodically bring.Historical precedent reminds us that in the past there was only an eleven per cent chance of losing money in shares if one held them for at least two years, and that there has never been a period of losing money in equity over a four-year period.The default is to be in shares, unless one is particularly fearful of a prolonged bear market.Our crystal ball at Investec is not entirely cloud free, but on balance we do not expect a prolonged bear market.After the bounce that we have just had, perhaps we need to steel ourselves for a quarter or two of sideways moving markets along with that unpleasant companion called volatility.But in our opinion the next major move in equity is up, it is just a question of timing.We draw comfort from the fact that the US Federal Reserve has responded so aggressively to the unfolding credit crisis in the US and we fully expect further rate cuts in the ensuing quarter.As the US yield curve continues to steepen, bank balance sheets will be restored to greater health and anxiety levels are likely to recede.Furthermore, the equity market is forward looking and at the first sign of the bottoming in the US economy it is likely to begin to re-rate upwards.ECONOMIC PAIN The market will not wait until it is patently obvious to all and sundry that the economic pain is over, but will rise at the first faint signs of dawn on the horizon.Our best estimate is that this will occur some time towards year-end.In the meantime we consider that markets are relatively cheap, and so we would characterise 2008 as a “low-risk waiting period”.The downside from these levels is not especially daunting given the low valuations, and when the market takes off it will be too late to panic in.You need to be there in advance.Bottom line, wait patiently, live through the stress of losing money occasionally in order to reap the longer term financial benefits.* This article was contributed by James Hatuikulipi, portfolio manager, Investec Asset Management Namibia.Conventional wisdom from a number of market commentators was that it was time to batten the hatches, sell some of your equity portfolio and accept the inevitability of a mini bear market.The only question was how long the sell-off was going to last, with the bears arguing that we are in for a year or two of depressing returns.To an extent however, we at Investec argued publicly exactly the opposite.The speed of the sell-off in January was vicious, giving little opportunity to make any serious adjustments to one’s equity exposure. MARKET FEAR It was in this post-sell-off period in middle January that we considered that the market fear was so great that at the very least we would get a short-term upwards bounce from such an oversold position.And aside from that, the medium-term prospects did not look as bleak to us as to avoid the opportunity to buy high quality listed companies at bargain basement prices.Well that is all water under the bridge, in that markets have indeed bounced back over the past couple of weeks.The real question is what now? Do we congratulate ourselves on not panicking a while back and now use the modestly recovered share prices to sell, or do we hang in there for the long haul? Well, there are no guarantees, but in short we would hang in there and hold your shares.In many instances after we have sold we forget to buy the shares back as we wait for even better re-entry levels, but more importantly, over time on average shares have delivered returns approximately seven percent ahead of cash per annum.To earn this famed “equity risk premium” one needs to be invested in equity over time, and be prepared to suffer the heart failure that setbacks like the recent one periodically bring.Historical precedent reminds us that in the past there was only an eleven per cent chance of losing money in shares if one held them for at least two years, and that there has never been a period of losing money in equity over a four-year period.The default is to be in shares, unless one is particularly fearful of a prolonged bear market.Our crystal ball at Investec is not entirely cloud free, but on balance we do not expect a prolonged bear market.After the bounce that we have just had, perhaps we need to steel ourselves for a quarter or two of sideways moving markets along with that unpleasant companion called volatility.But in our opinion the next major move in equity is up, it is just a question of timing.We draw comfort from the fact that the US Federal Reserve has responded so aggressively to the unfolding credit crisis in the US and we fully expect further rate cuts in the ensuing quarter.As the US yield curve continues to steepen, bank balance sheets will be restored to greater health and anxiety levels are likely to recede.Furthermore, the equity market is forward looking and at the first sign of the bottoming in the US economy it is likely to begin to re-rate upwards. ECONOMIC PAIN The market will not wait until it is patently obvious to all and sundry that the economic pain is over, but will rise at the first faint signs of dawn on the horizon.Our best estimate is that this will occur some time towards year-end.In the meantime we consider that markets are relatively cheap, and so we would characterise 2008 as a “low-risk waiting period”.The downside from these levels is not especially daunting given the low valuations, and when the market takes off it will be too late to panic in.You need to be there in advance.Bottom line, wait patiently, live through the stress of losing money occasionally in order to reap the longer term financial benefits. * This article was contributed by James Hatuikulipi, portfolio manager, Investec Asset Management Namibia.