Pegasus View January 2008
By Yvonne Staples
Concerns regarding the freeze-up in credit markets and its impact on the broader global economy really took hold in the fourth quarter of 2007, resulting in another period of turbulence in the markets. While concerns over US housing and sub-prime mortgages had been bubbling under the surface for some time, the general view was that it was contained and very much an American problem, although the third quarter volatility in credit and equity markets hinted at a more sinister outcome. Central banks did however come to the rescue, led by the Federal Reserve who cut interest rates. This restored investor confidence and global equities entered the final quarter in better spirits. Unfortunately, this momentum was not too last.
It has been an eventful and volatile month so far for financial markets with the worst start for equities in more than 40 years. This is however a most unusual crisis……… This month’s exceptional market declines combine fears of the unhinging of the financial system on one side, with quite extraordinary pools of global liquidity on the other. We have capital starvation on Wall Street at the same time as unprecedented levels of foreign exchange and sovereign reserves in Asia and the gulf. And, while banks suffer, the corporate earnings from many industrial “blue chips” are at close to record levels. We have in other words a dislocation of global liquidity. The biggest story this year has been the surprise inter-meeting rate cut of 75 basis points by the Federal Reserve which was the largest single rate cut since the 1980s. The fed have this week cut rates by another 50 basis points lowering the US dollar base rate to 3%. The Fed is hoping the cuts will cushion the US economy from the worst effects of the credit crunch and housing slump. In this uncertain environment, the main focus for our managers has been limiting risk and volatility. A cautious stance towards the end of 2007 has allowed managers to be cash rich entering 2008, enabling them to now actively deploy this liquidity into new opportunities. They have been heavily underweight financials and overweight basic materials and industrials.
The commodity story seems set to continue into 2008, with agricultural commodities, precious metals and oil all flying high on the back of demand from investors and speculators alike. The potential global impact of a US slowdown has led to increasing risk aversion and profit-taking in markets around the world, but our outlook for China remains positive. This is based on the continuing expansion of the Chinese economy and the growth of domestic demand that is making the economy less reliant on exports to the USA. We talked about Africa in our last review and indicated that this region (if you take out South Africa) had a very low correlation to the rest of the world. This has in fact been proven in the year to date performance figures for African equities, which are now down 1%, while the MSCI World is down 9%.
In summary, America may be the one to watch in 2008. It has its problems, but a lot of bad news has already been discounted and the Federal Reserve is working hard to get the economy on its feet. Furthermore, sovereign wealth funds will be particularly keen to snap up bargains that side of the Atlantic. Having underperformed over the last five years, Wall Street may finally be due its time in the sun.