Monday, March 19, 2007

Are we near the end of the current shake-up?

Over the last two weeks the stock markets worldwide have been very volatile. It was first triggered by the Chinese stock market falling 9% in one day, then by the nervousness in the US about the fallout in its sub-prime lending market. Our own JSE has seen days with more than 2% or 600 points movements in the Index.

The question on every investor's mind is: Is the worst over, or still more downside to come?
Consider the following:
  1. The loose lending practice in the US shows up the banks in the now higher interest rate environment, as many lower income home owners cannot afford the instalments. Banks repossess these houses, forcing home owners to vacate their properties. It is estimated up to 1 million home owners face such fate. This is bound to have social and economical ripple effect in the US.
  2. Inflation continues to be a concern. The oil price hovers around $60 per barrel; climate changes cause droughts in many parts of South Africa, hurting crop output. Maize prices are rising rapidly, which will impact other food prices. Higher inflation is likely to lead to further interest rate hikes by the Reserve Bank. As we know, higher interest rates are generally bad for the stock markets.
  3. Geopolitical problems: Iraq, Israel-Palestinian, Zimbabwe, and ongoing terrorist threats. These risks have not been priced into the valuations of stock markets.
  4. Trade imbalances and carry trades: A lot has been writtten about trade imbalances and carry trades. The US runs huge fiscal and trade deficits, while China has big trade surpluses, flooding its economy and stock markets with cash. The low interest rate in Japan has made carry trades a worthwhile, profitable transaction, increasing money flows into global stock markets. If not properly managed, these imbalances may cause disruptions to the world economy and negative consequences to the stock markets.
  5. An article we published at the beginning of the year suggests the JSE is in expensive territory, and more volatilities and downside are likely.

Given the reasons above, we expect the JSE to move sideways or down for at least the next couple of months, if not longer.

Accordingly, traders should trade with lots of caution. Investors should be patient in sitting out the volatilities.

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