The roller coaster ride continued through the second quarter of 2001, with few surprises for investors, as we had anticipated. Investor sentiment was given a much needed boost with the 6 interest rate cuts in the USA, for the year to date, and one in the European Union. We still believe that short-term volatility is here to stay – so keep your seat belt fastened.
In the USA the Dow Jones Industrial Index has lost 2.57% for the year to date, while the Nasdaq has shed 12.48% over the same period. Alan Greenspan has continued to cut interest rates over the past quarter, bringing USA rates down to 3.75% – the lowest level since April 1994. The last cut of 0.25% disappointed some investors who were anticipating another 50 basis point cut (the previous 5 interest rate cuts each being 0.50%) – some analysts were pleased with the lower cut, being of the opinion that the Federal Reserve are taking potential inflationary concerns into account. The first quarter growth rate, which was anticipated at 2%, came in at 1.3%. As mentioned in our last report, the outlook for corporate profits and the economy still remains unclear and we are of the opinion that the current levels of volatility in USA equity markets will continue until the outlook becomes clearer. The positive lag effects of the quick and aggressive interest rate cuts by the Federal Reserve, together with the tax cuts recently implemented by the Bush administration, should start becoming evident during the second half of the year.
Higher oil and import prices, together with slowing growth, have been the main contributory factors to the interest rate policy dilemma currently prevalent in Europe. In a surprise move, the European Central Bank (ECB) cut interest rates by 25 basis points in May, bringing interest rates down to 4.5%. Key interest rates were left unchanged at the June meeting of the ECB. At present, inflation is above the current target level of 2%. These inflationary pressures are preventing the ECB from cutting interest rates further, in an attempt to stimulate growth in this region. Stock market volatility has continued in Europe over the past three months – investors have been influenced largely by earnings forecasts and results in the USA. The Euro still appears to be out of favour, however many analysts still remain optimistic about seeing the Euro ending the year at parity to the US Dollar. Our expectation for a stronger Euro is more optimistic from next year, once the actual currency comes into circulation. There has also been much speculation in the market recently about Britain joining the EU – if this were to happen, we anticipate that it would happen sooner rather than later, as Mr Blair has less than 5 years in which to make this transition. Such a move would prove to be positive for the Euro.
Deteriorating business confidence, falling factory production and rising unemployment are some of the factors fuelling current fears that the Japanese economy may slide back into a recession. Exports from Japan have continued to decline and are another cause for concern. In May, Japan’s trade surplus declined for the 11th consecutive month – falling over 86% for the year. The appointment of the new Prime Minister was well received, mainly because of the positive outlook for restructuring, but many are of the opinion that this may not be enough for the Japanese economy to overcome the prevailing negative pressures in order to bring about economic recovery over the longer term. We continue to believe that, economic growth over the long term will only be possible if consumer confidence returns and corporate restructuring takes place to make companies more profitable. We expect market volatility to continue in Japan for at least as long as volatility remains a feature of equity markets in the USA.
Asianmarkets have not escaped the negative impact brought about by the slowdown is the USA, Europe and Japan. Political instability in certain countries and sharp volatility have served to dampen investor sentiment. Signs of an economic slowdown in this region are prevalent, while many countries are in the process of easing monetary policy in order to stimulate growth. Asian companies appear, on the whole, to be attractively valued, although an abundance of supply may impact negatively on this region’s markets over the short term. Corporate restructuring remains key for the long term outlook of this region.
As alluded to in our last quarterly report, the SA Reserve Bank cut the Repo Rate (the rate at which commercial banks borrow from the Reserve Bank) by 1% on 15 June 2001. The major banks followed suit by cutting their lending rates by 0.75% encouraged by, amongst other things, the sharp drop in the net open forward position and the positive effect this should have on future domestic economic growth. Tito Mboweni, SARB Governor, is quoted as saying that the interest rate cut was made possible by clear indications that inflation is slowing (headline inflation declined to 6.4% year on year in May, compared to 6.5% in April). The potential for another interest rate cut in the coming months is good, although prudence is required when considering the short term stability of our currency – other than external macro-economic factors, one factor that could have a negative effect in the short term is the potential volatility of oil prices. Consumer and business confidence remain low – an increase in spending may possibly only become evident once the recent reduction in lending rates appears to be sustainable. The JSE has performed reasonably during the first half of this year, while the general outlook for the domestic market over the short term is fair. It is important to remember that South Africa is an emerging market and, as such, the risks associated with investing domestically are higher than those associated with a globally diversified portfolio.
The first half of 2001 has certainly proved to be a roller coaster ride for global investors. This highlights, once again, the importance of portfolio diversification. Of particular interest are Alternative Investment Strategies that have been introduced as a fourth asset class – known to many as hedge funds. Hedge funds target consistent and positive returns to enhance long term capital growth regardless of whether the underlying markets are rising or falling.
Alternative Investment Strategies (hedge funds) have finally become available to the individual investor (due to the initial investment amount being reduced to an acceptable level through the multi-manager system) and in light of the current volatility in global markets, they are an extremely attractive compliment for the three traditional asset classes, being cash, bonds and equities. For your interest, the Olympia Star Hedge Fund has a 10 year track record, with an annualised net return after costs, of 13.94% – this is a low risk fund (of particular interest, is the fact that it achieved 18.79% in US Dollars in 2000, while worldwide equities lost approximately 25%). This product is currently available through us at reduced costs via Investec Assurance.
“Not all hedge funds are the high risk, volatile investment vehicles that many believe they are. These funds are, in fact, rapidly gaining acceptance within the portfolios of endowments and pension funds, typically some of the most risk averse players in the investment world.”
Some of the key benefits of hedge funds are: lower volatility, lower risk and higher risk adjusted returns and have little or no correlation to equity bond markets.
Many hedge funds are available in the market, but few of these funds have been approved by the Financial Services Board, and as such cannot be actively marketed in South Africa. This has been done to protect the investor from potentially unscrupulous investment offerings.
Should you wish to know more about the FSB approved hedge funds, please do not hesitate to contact us.
This report is based on information sourced from various institutions, both local and international. The report reflects a variety of views and is not intended to convey investment advice. Please consult us to obtain specific advice relevant to your investment portfolio.
