A Word with Hugh Hendry and friends

Emerging markets fear effects of sabre-rattling **(from Business day Oct 12th)


As anniversary of September 11 attacks looms, US threat against Iraq not welcome
WITH the anniversary of the September 11 attacks on the US this Wednesday, the sabre-rattling in the US over Iraq could not have come at a worse time for US and world markets, and psychologically the next few weeks are likely be scary for many investors.
Bearish sentiment weighed heavily on markets last week, a stark reminder of the havoc the terror attacks played with investor confidence last year, probably marking the beginning of the prolonged bear market in the US and elsewhere.
It was especially bad for emerging markets like SA, and probably marked the beginning of the slide that saw the rand lose 37% of its value against the dollar by year-end.
The bear market reasserted its grip on share prices last week, with little to calm nerves. The US market fell 4% on Tuesday last week, while Japanese share prices touched 19year lows on Wednesday.
Brokers returned from their holidays to see no clear upturn in the US economy as yet, and the corporate earnings outlook has worsened.
Ironically, in times of such turbulence, the US is seen as a safe haven and so sucks capital out of other areas. Fundamentals count for little and emerging market currencies such as the rand are likely to come under renewed pressure.
If that, and the threat of war between the US and Iraq, were not enough, investors will have to deal with other feared anniversaries: the Wall Street crashes of October 1929 and 1987. Investors are generally uneasy about these anniversaries and especially so this year. That is also likely to prove to be a curse for emerging market currencies.
And all this will be happening in the context of a bear market that shows little sign of springing to life. The upturn in global prices over the summer has been patchy. "It was the least-quality stocks that led the way over the summer, such as the insurers, small firms, Japanese banks," says Michael Hughes, chief investment officer at Baring Asset Management. "We need to see the money coming back into better long-term investments."
Another aspect of the summer run-up in price was that markets rose on the back of very low volumes. Much of the activity has been led by hedge funds exploiting shortterm price discrepancies. Longerterm buyers, meanwhile, have proved few and far between.
"The feeling in the market has been to seize on any rally in prices as a sign of a turning-point in the market or a longer-term rally rather than to be sceptical," says Chris Carter, chief strategist at Investec Asset Management. "History shows us that severe bear markets reach the bottom when no one is looking."
That cautious optimism now seems to have evaporated. Traders have seized on a series of economic data demonstrating weakness in the US economy as a reason for a further sell-off.
The influential Institute of Supply Management's survey of US manufacturing activity showed US output was flat last month for the second consecutive month. This intensified economists' fears of a double-dip recession in the US and traders also picked up on the more pessimistic outlook for new orders, at its lowest since last November.
Emerging markets are caught in a difficult, lose-lose situation. On a psychological level, there are so many reasons why investors should desert them for safe havens like the dollar or Swiss frank.
Now, with the US economy standing on shaky ground, the fundamentals are also stacked against markets like SA. If the US does fall into recession again, that will mean there will be less demand for SA's commodity exports.
Likewise, for much of east Asia. If their economies falter on slower US demand they have less need for SA's commodities. There seems to be little or no good news on the horizon. As if to reinforce the change in mood, UK share prices have also weakened, in spite of data released this week showing that the economy was improving modestly.
Followers of historic trends point out September is often a weak month for share prices. For example, of the past 100 years, 58 have seen a sell-off in September.
Another negative pointer is the fact that the Dow Jones blue-chip index closed down at the end of August the fifth consecutive month US stock prices showed an overall decline. The last time that occurred was more than 20 years ago, in 1981.
"I have watched those US traders try to push the market up and they couldn't do it," says Hugh Hendry, who runs hedge funds at CF Odey, an asset management company. "It confirmed the bear market. That meant I was out selling aggressively on Monday and buying bonds."
Bears such as Hendry cite company dividend yields as a sign share prices are not particularly cheap and could fall further. The yield on US stocks about 1,8% is still far too low to entice buyers, who typically seek a yield of 5% or more.
Corporate earnings forecasts are also being marked down, adding to the sense of gloom about the global business outlook.
The problem for European investors is UK and European share prices now look more in line with historical valuations and yet these markets cannot shake off the powerful influence of US pessimism.
US economic prospects are expected largely to determine share prices in coming weeks as fears of a double-dip recession reverberate in dealing rooms. "Last year it was a corporate recession and I can't see how you can avoid a consumer recession this year," says Carter.
In particular, weaker consumer confidence in the US and any downturn in the housing market in the US and UK are likely to have a powerful effect on share prices.
Global share prices are also being influenced by the bleak outlook for the Japanese economy, where the government's budget deficit continues to grow and banks' capital ratios are under extreme pressure as share prices tumble. With Financial Times