Just over a year ago (on January 14, 2006) I wrote about the perils of ignoring momentum in your portfolio. It is with a sense of déjà vu that I observe the equity markets at the start of 2007. Strong buying - almost certainly driven by liquidity in the case of China and the emerging markets - has pushed up equity markets worldwide, particularly emerging markets.
One can almost visualise the portfolio construction orders to increase exposure to emerging markets that asset allocation teams emailed to fund managers around the world, and hear the mouse click triggering the orders.
Impressive recovery
Reflecting on last year, the strong equity markets in the first quarter preceded the sharp but short-lived decline in the middle of the year. Volatility levels shot up, reflecting the aversion to risk that investors felt at the time.
However, equity markets recovered by the end of the year, and emerging markets staged an impressive recovery, strongly outpacing the likes of the United States and Japan. Bond yields, on the other hand, rose in response to strong economic data, particularly from the US, as the year drew to a close.
For much of last year, global market watchers expressed concern about the outlook for inflation (high oil prices were a major factor) and the housing market in the US, where consumer debt was at levels higher than those seen for many years. As the oil price dropped from its high for 2006 of US$78 to its current level of about US$53, not only did investors review their pessimistic outlook on inflation, but consumers ended up with more money in their pockets as they spent less on heating and transport. As an added bonus, warmer weather in the northern hemisphere meant that consumers had to spend less on heating, regardless of what the oil and gas prices would have been.
So, the average consumers in these regions bought less fuel, and what they did buy cost them less than before. One warm winter with lower oil prices does not obliterate the potential negative impact of the weakness in the US housing market on the US economy, but it certainly provides some welcome relief.
Changed emphasis
Let's return to momentum. It is certainly alive and well in the South African equity market, but the sector emphasis has changed.
For most of last year, the resource sector displayed the most upward momentum. However, by the end of the year we started to see some cyclical rotation, with the resource index only a few percentage points ahead of the general market for the year and 10 percent behind over the fourth quarter.
So far in 2007, it has been a poor year for resource shares in general. They lagged the rest of the market in January, and some of them have probably declined so fast they are ready for a short-term bounce. However, the long-term picture is what interests me.
Slower momentum
A closer look at the longer-term momentum charts of the larger shares reveals an interesting story.
Although many of the resource share prices still display positive momentum (in other words, their share prices are moving up when compared with their levels of a few months ago), they are rising more slowly, if at all.
It is in the other sectors of the market that the momentum is picking up. Banks, life assurers and industrials, such as Bidvest and Imperial, are showing a perkier momentum picture. Listening to market commentators, the fears about global inflation seem to have abated, largely as a result of the lower oil price.
This is the case in the local market as well, and would explain investors' renewed interest in these non-commodity sectors.
It is also in this part of the market where you can still find dividend yields of over three percent in the larger shares and over four percent for many mid-sized industrial and financial shares.
Don't you yearn for the six-percenters that were quite freely available in 2004?
Another area that is showing momentum is information technology (IT). Unfortunately, in South Africa there are currently fewer options for larger investors than was the case a few years ago, but there are still quite a few choices for the smaller investors.
I had to smile when I came across a USA Today article from March 2005 that proudly listed 10 reasons why the Nasdaq would not recover any time soon. March 2005 was not exactly the bottom of the Nasdaq since it peaked in 2000, but the index has not returned to the low at which it traded when the USA Today article was written.
Granted, the range of investment opportunities in the Nasdaq is much wider than among the local IT shares, but some of the growth drivers are similar, so it is interesting to look at some simple reasons why tech stocks should have recovered despite the well-written argument to the contrary.
While their price:earnings (p:e) ratios have tumbled since 2000, many IT companies are still well managed, producing great, innovative products and services, and a growing profit stream. The only difference is that, in the case of Cisco, you are paying, one-fifth of its peak value, as measured by its p:e ratio - even after a 50-percent increase in the share price in the past year.
In the seven years following the Y2K-driven spending, companies have had to continue or resume spending on technology in order to compete, internet usage has continued to grow, gadgets abound and, as a result, increases in consumer spending tend to have a closer link to increased spending on technology.
Think about it: have iPod ... need iTunes ... need broadband need family network need bigger hard drive need faster processor.
It is the extremes in sentiment, either positive or negative, that can provide great investment opportunities, but these do not come around all that often. Of course, it is difficult to measure these extremes, but momentum can provide you with a few clues.
At the moment, clues about sentiment can be found in rising or falling momentum, rather than in extreme levels of momentum, and this is where industrial and financial shares catch the eye. Investor interest in these sectors is picking up, and that always warrants a closer look.
- Anet Ahern is the chief executive of Sanlam Multi Manager International.