Volatility is back again and is possibly here to stay. The returns for the first two months of 2007 belie the increasing discomfort that investors around the world and locally have started feeling about equity markets and, in particular, emerging markets. The moves in China are well publicised, and we have seen large one-day declines in markets around the globe during the past week.
I hate market truisms. "Sell in May and go away" definitely backfired last year (the equity market is up 27 percent since last May, and 40 percent, if you happened to pick the June bottom perfectly).
As for the "January effect", I wrote about this phenomenon in January 2005. Essentially, it is supposed to be about stocks doing better in January than in other months. January moves determine the direction for the year and smaller stocks do better than larger ones.
January was a good month for equities, with a two-percent gain for the month and another one percent added in February. Small caps have indeed had a great run, up over 10 percent so far this year.
However, even this paragraph gives too much credit to this cliché, given what happened this week.
Let's examine the events of the last week from three angles. Firstly, let's look at the extent of the short-term moves within the context of the past. Next, let's look at the foundation or fundamental background of the local equity market. Finally, let's look at the messages from international investors regarding recent moves.
How big is big?
Looking at the daily movement in the JSE over the past four years, it is clear that most of the time, the market moves between one percent up and one percent down every day, averaging around 0.1 percent. Over this period, the largest down-day was six percent down (June 2006).
However, the biggest up-days were also in June last year, with moves around five percent a day as the market bounced back. It would be fair to say that the moves during the past week were not the biggest daily moves we have seen, but also to note that down-days are often clustered together. Where there is one, there are often more to come. That is why you need to keep your cool and not to react to short-term volatility.
Secondly, let's look at the fundamental background of our equity market and the globe. Economic and earnings growth still look positive, while slowing somewhat.
Both the budget and recent interest rate indications are supportive.
The price:earnings (p:e) ratio of our market and some of the major markets internationally could best be described as fair, certainly above average, but not expensive either, especially if one looks at individual shares with p:e ratios ranging from seven to over 40, and many clustered around the 14 to 16 range.
So it would be fair to say that the often-repeated prediction that the local equity market is unlikely to repeat the excellent returns of the last few years has a good chance of finally coming true.
This does not mean that the long-term investor with either a discerning choice of fund manager or individual shares needs to panic.
The p:e ratio of the overall market is more or less where it was last May, when we saw widespread panic and volatility, but also the opportunity to pick up individual shares at great levels.
Emerging markets
While emerging economies are likely to continue growing faster than the overall global economy, their equity markets are no longer screaming value when compared with the rest of the world. The world is still awash with liquidity and this has contributed to the strong markets we have seen so far this year as well as last year.
In my column of June 2, I wrote about market volatility and the significance of the VIX index.
Last May, the index moved from a low of around 10 to over 20 in a short space of time, only to retreat all the way back down as investors' confidence returned.
During the past week, we saw the indicator spike to over 18, reflecting investor concerns. We are likely to see more volatile markets given recent investor behaviour, and the continued importance of liquidity - essentially the availability of cash and the cost of borrowing - in driving market moves. This is always a difficult influence to try to assess as it can last longer than expected and have a big impact on the market, but it can also dry up very quickly.
So what does one do now?
Here are some pointers to consider:
- If you have recently started investing in equities, keep staggering your contributions over time to take advantage of lower prices if and when they come. Make sure your overall investment plan reflects the amount of risk you are prepared to take, how long you have to achieve your goal, and a proper mix of assets, which includes an offshore component.
- Remember that as a smaller investor you are in a position to select a portfolio that is very different from the overall market and can focus on more defensive and higher-yielding shares. If you follow the equity market, focus on the levels at which you think particular shares offer great value in the long term and take advantage of panic days to top up your holdings.
- If you have enjoyed the gains of the past few years with a full weighting in local equities, consider switching some of your investments into more flexible options, such as absolute return or flexible funds. You may find that you don't even have to switch to another investment company, which may save you some costs.
- Consider some offshore investments if you have not already done so, as emerging-market jitters are often accompanied by weaker currencies in those countries, so you benefit from diversification as well as a potentially weaker rand. There are easily accessible rand-based funds with a spread of assets spanning offshore equities, cash, property and bonds available in the local market, so you don't even need to apply for a foreign exchange allowance.
- Look at your balance sheet in totality. This is not the best time to be heavily geared to finance equity investments.
- At all times consider your time horizon, your tolerance for more volatile markets and the overall make-up of your portfolio. This is more important than a short-term assessment of the market. Remember that equities offer excellent growth as part of a long-term investment plan.
The longer your time horizon, the more volatility you can stomach.
- Anet Ahern is the chief executive of Sanlam Multi Manager International