Download 30 June 2007 Balance Nature strives for balance. In the wild, lions

30 June 2007
Balance
Nature strives for balance. In the wild, lions eat the
antelope until there are too few left to sustain the
lion population. The lions then struggle to catch
the remaining antelope until some of them starve
or move away. Eventually the antelope population
recovers until their numbers are in balance with
the predators in their ecosystem.
Listed companies could be seeking to monetise
their future earnings, raise capital or have other
goals made possible by a public listing. Investors
might be looking for a safe haven, inflation
beating returns or the latest speculation.
So while one takes solace from averages and
The economy and the financial market that exists
within it are a man made system, which unlike
trends,
the
market
is
constantly
over
and
undershooting as it tries to find its balance.
nature, never maintains a position of equilibrium
MONTHLY PERCENTAGE CHANGE
ALL SHARE INDEX
for very long.
In simple theoretical terms the equity market
should appreciate at the nominal rate of aggregate
earnings growth, assuming that investors have
correctly estimated future earnings growth and
selected the correct discount rate. We know this to
be correct because over the long term, equity
market returns are quite stable. However in the
short to medium term the market struggles to
forecast earnings growth accurately. Investors veer
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between over and underestimating future earnings
as they attempt to make sense of a never ending
barrage of information and opinion.
firmly on the side of the bulls, but after 277%
In addition, the various market participants do not
all have the same objectives. The Reserve Bank is
trying to manage inflation and growth. The
Finance Minister is trying to encourage economic
growth,
collect
taxes
government’s cheque book.
and
For the last 4 years the market has been weighted
balance
the
growth just how balanced is the equity market?
Analysing the strong market growth shows us that
although earnings have risen by a robust 113%
since 2003, the All Share Index PE ratio has
climbed from 9 to 16. Some of the rise in the
market multiple can be ascribed to the fall in
interest rates from a high of 17% to a low of 10,5%
in 2005.
Yet interest rates have risen by 250 basis points in
The building companies will also have to deal with
power ahead.
deadlines in order to convert revenues into profits.
the last 12 months and equities have continued to
From this point there does not
appear to be much room for further share market
skills and material shortages, as well as tight
An
gains as a result of improvements in valuation.
important
factor
not
to
neglect
when
considering the outlook for equities is the global
picture. The global bull market has been fed on a
18.0
18.0
17.0
17.0
16.0
16.0
15.0
15.0
14.0
14.0
13.0
13.0
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12.0
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11.0
10.0
10.0
This behaviour is evident in the gap between US
9.0
9.0
Government
8.5
8.5
8.5
2003
2004
PRIME OVERDRAFT RATE SA (13)
2005
2006
2007
ALL SHARE INDEX [PE] (16.41)
high calorie diet of cheap money. Although
interest rates have bottomed, the spreads between
risky and less risky investments have remained
narrow, encouraging risk seeking behaviour.
Treasuries
and
the
bonds
of
emerging markets. Since the crisis of 1998 the
additional yield that investors earn by taking the
risk of buying emerging market bonds over US
The implication must be that South African
investors
are
Treasuries has shrunk from 1000 basis points to
growth,
especially
emerging
very
confident
from
construction related companies.
about
earnings
commodity
and
165 basis points. Such a narrow spread leaves
markets
vulnerable
to
negative
developments, which could rapidly affect their
bonds and equities.
Strong commodity prices have been underpinned
by supply shortages and strong demand from
Another threat to risk seeking behaviour comes
strategy on the continued expansion of a centrally
so-called sub-prime sector. Lenders have been
exchange rate. We firmly believe that China will be
customers on increasingly laid-back criteria. One
but
income, so called liar loans, with an interest rate
China. We are unwilling to pin our investment
managed, opaque economy with a managed
a major influence on the world for years to come
doubt
whether
their
conversion
to
a
prosperous market economy will be achieved
without some major hiccups along the way. There
from the lower end of the US housing market, the
granting
mortgages
to
less
credit
worthy
example would be loans granted without proof of
set at a low level for the first two years.
is also a massive supply side response underway
These mortgages have then been packaged into
so shortages in commodities are unlikely to
so-called collateralised debt obligations (CDO)
persist into the future.
South African infrastructure is another strong
with differing levels of risk and on-sold to
investors.
growth story. Government spending on the 2010
As the rates on these low quality loans have reset
Gautrain and various private sector initiatives all,
growing number of homeowners have defaulted.
sector’s revenues.
homebuilding industry, taking with it builders,
World Cup and other infrastructure projects,
provide a significant underpin to the construction
growth
is
already
In our opinion much of the
reflected
in
the
sector’s
on
their
two
year
anniversaries,
a
This has resulted in an implosion in the US
mortgage originators and ultimately the CDO’s
that are backed by sub-prime mortgages secured
valuations.
Hermes Asset Management (Pty) Ltd
upwards
by houses.
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One early casualty has been investment bank Bear
Stearns, which had to pay $3bn, or a quarter of its
capital to rescue one of its hedge funds that was
active in the CDO market. As these mortgage
backed instruments are not priced daily in an open
exchange, there is still much more pain to come,
while another 2 million mortgages will reset to
higher
rates
in
coming
months,
potentially
escalating the level of defaults. Estimates of the
ultimate losses from sub-prime lending range
from $50bn to $250bn.
Such
huge
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Fund Awards for 2007.
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But what does this matter to investors in South
Africa?
Hermes Management Company was awarded
losses
on
low
quality
investments will encourage lenders to demand
higher returns on risky loans. The recent buy-out
of Edgars was affected, when the yield on the debt
instruments funding the deal had to be raised to
ensure its success. Emerging markets might also
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find investors less willing to accept a historically
narrow premium over developed markets.
Hermes Asset Management (Pty) Ltd does not take any
responsibility for any portfolio actions that readers may take on
In summary, we would caution that the current
equity bull market is getting increasingly mature
and that investors should be aware that returns in
the near future are unlikely to match those of the
spectacular last four years
Collective Investment Schemes in Securities (unit trusts) are
generally medium to long-term investments. The value of
participatory interests (units) may go down as well as up and
past performance is not necessarily a guide to the future. Unit
trusts are traded at ruling prices and can engage in scrip lending
Returning to the wildlife analogy, one wants to
avoid being an old bull in a field stripped of
sheltering vegetation, when the lions are hungry.
and borrowing.
Different classes of units may apply to these portfolios and are
subject to different fees and charges. Unit trust prices are
calculated on a net asset value basis, which is the total value of
all assets in the portfolio including any income accruals and less
Contact
any permissible deductions (brokerage, UST, VAT, auditor’s fees,
bank charges, trustee and custodian fees, and the annual
management fee) from the portfolio, divided by the number of
Philip Thompson
units in issue. A schedule of fees, charges, and maximum
Arthur Karas
commissions is available on request. Hermes portfolios are
valued
Bill McAdam
Telephone:
Facsimile:
daily
at
3pm.
Instructions
must
reach
Hermes
Management Company (Pty) Ltd before 2pm to ensure same-day
value. The Hermes Equity Fund Class A has an annualised Total
021 795 6000
Expense Ratio (TER) of 1.24%. For the period from 1 January
021 795 6060
2007 to 30 June 2007 0.62% of the average Net Asset Value of
the portfolio were incurred as charges, levies and fees The
E-Mail: [email protected]
Web:
the basis of this document.
Hermes Flexible Fund Class A has an annualised Total Expense
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Ratio (TER) of 1.12%. For the period from 1 January 2007 to 30
June 2007, 0.56% of the average Net Asset Value of the portfolio
were incurred as charges, levies and fees. A higher TER ratio
does not necessarily imply a poor return, nor does a low TER
imply a good return. The current TER can not be regarded as an
indication of future TER’s.
Hermes Asset Management (Pty) Ltd
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