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Send  Share  RSS  Twitter  28 Nov 2010

INVESTMENT: Investors Cautiously Optimistic


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Pleasing macroeconomic data and policy-maker support for developed world economies have put investors’ minds at ease for now, but most financial advisors and institutional investors polled in the November Sanlam Investment Management (SIM) Investor Confidence Index (ICI) do not believe the market is currently cheap.

According to Candice Paine, head of retail at Cape Town-based SIM, equity markets around the globe have had a good run recently, but while a double-dip recession has probably been averted, a jobless recovery almost guarantees muted growth. “As a result, although investors may currently be relieved, they are not overly confident.”

Federal Reserve Chairman Ben Bernanke summed this sentiment up recently when testifying before Congress saying that the economic outlook remained “unusually uncertain”. This cautious optimism has so far been justified locally given the FTSE/JSE All Share Index’s respectable returns recently. It began the year at an index level of 27 666 and has added almost 17 percent to more than 31 500. On the back of this rally, the SIM index captured a less buoyant outlook as most recipients are expecting low to negative returns from equity markets in the next one to three months and only marginally positive performance thereafter. However, a high probability of a market crash or sustained negative stock market performance was not widely supported.

This moderate view of future performance is supported by the Valuation Confidence Index, which compares stock prices with measures of true fundamental value to determine how fairly the market is priced. Paine says that broadly speaking none of the participants believe the market is currently cheap, a view consistently held since December 2009. “While everyone agrees that the market isn’t cheap, 40 percent of respondents view the market as not too high, while 60 percent consider it expensive. As equity markets keep climbing, the percentage of participants viewing the market as expensive keeps growing. It would seem that while investors do not fear the worst, concern over slow earnings growth still informs sentiment.” 

The results of the index since December 2009 may leave you wondering why the market has added almost 17 percent despite participants’ views that stock prices have been expensive, says Gerda van der Linde, Executive Director at the Institute of Behavioural Finance. “Over this period, participants have continued to expect returns to be below 4 percent for the next six months and less than 8 percent for the next 12 months.

Behavioural finance research shows that markets can be inefficient for much longer periods than expected. Markets are regarded as inefficient if basic fundamentals are ignored. Experts warn that the mistake investors often make is to look at a stock market they believe is overvalued and think that its price will quickly move to fundamental value. In many cases the mispricing of assets widens before they move back to their fundamental value,” she observes.

So what is an investor to make of a ‘fairly valued’ market? “It is important to remember that in the near term a share’s performance on the stock market may be driven by changes in expectations and investor sentiment and not necessarily by anything the company has actually done,” explains Paine. “As a result, an investor should be cautious when making decisions in this environment. A good fund manager will still be able to identify stocks that are trading below their intrinsic value, but on average most stocks are trading at fair value and some are expensive. What is important is to take the emotion out of investing and stick to a disciplined strategy that involves not overpaying for assets and investing for the long term.”

Van der Linde believes that the only certainty in investment markets seems to be the consensus that stock prices and stock market returns will remain uncertain for the immediate future. “It is no surprise that fixed interest funds attracted the bulk of the R29 billion net inflows into South African mutual funds in the third quarter of 2010. Loss aversion, or the fear of losing money, is still the strongest emotion after the meltdown experienced in the not so recent past. “When we contemplate uncertainty, what we are really contemplating is risk. All unknown outcomes contain risk, and therein lies the possibility of loss.

Investors with a short-term horizon and a low risk appetite are most probably those being advised by their financial planners to stick to less risky investment options. While investors with a longer time horizon and higher risk tolerance may have started to invest in equities again. Leon Campher, CEO of ASISA, rightly said recently that although equities will always be accompanied by volatility, sometimes resulting in prolonged uncertainty, they do reward with better returns over the long term.”

Van der Linde and her team believe that investors should rely on the advice of licensed certified financial planners to guide them in their investment decisions. “These financial planners follow a scientific financial planning process to establish the risk profile of the investor, resulting in an investment policy statement which will guide investing,” she explains. “When there is conflict between what we think and what we feel, what we feel will win. That is why investors need the discipline of a detailed financial roadmap managed by a professional.”

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