Some Notes on the World around Us

The October 2008 World Financial Crisis – 4 November 2008

The October 2008 world financial crisis in a nutshell:

  • Banks found themselves unwilling to lend because they had run out of capital as a result of bad loans, especially mortgages.
  • This unwillingness to lend also included the unwillingness to lend to one another. As a result interbank money market activity (this is one of the principal lubricants of the industrial ‘gearbox’) virtually seized up. 
  • Apart from one’s bank, the easiest place to obtain cash is to draw on your savings (i.e. sell equity). Americans (individuals, mutual funds, pension funds, hedge funds, etc.) held $5.4 trillion in non-US equity. In Europe, the same situation occurred whilst approximately the same international equity holdings prevailed.
  • The result was a great wave of stock (equity) finding its way to markets, both developed and emerging. Do not underestimate the power of the margin call in a falling market – stock markets are more liquid than debt markets.

What followed was a large-scale international sell-off of any and all equities which was motivated by the dire need to get cash at any cost which further caused mass panic during which shareholders sold without thinking. This was not stock specific as all equities were tarred by the same brush during a time which sellers displayed unlimited irrational pessimism.

Investment managers should never be speculators but rather long term seekers of value and should certainly not participate in irrational sales sprees like these. At such times, difficult as it may be, Investment Managers must rather conduct research in order to find good (reputable) companies with sustainable (resilient) earnings streams in which to invest in. 

The question on everyone’s lips now is at what point in time debt and equity markets will recover from the current drawdown? A recovery may happen quicker than generally expected because of four factors which are peculiar to this particular market drawdown:

  • The attention to and focus on the debt and equity markets by the governments of major economies.
  • The extraordinary lengths that the US, British and European governments have gone to in an effort to re-capitalize banks and provide liquidity to the banking system.
  • The moment that the credit and interbank markets begin to function normally, the equity markets will resume some of their customary composure because credit fears will have died down. 
  • Markets, both developed and emerging, have been sold to very inexpensive levels historically.

Since mid-October 2008 authorities all over the globe started acting (more) in concert to address capital market and economic growth concerns. Those in the developed world are the USA, the UK, Switzerland, Japan, France, Germany, The Netherlands and Iceland. Many emerging countries including China, Russia and India followed the developed world’s example to calm the fear in financial markets. They employed one or more of the following potent financial tools to intervene:

  • Liquidity; a reduction in reserve requirements and lending guarantees to the banking sector and a reduction in withholding taxes on interest.
  • A concerted worldwide reduction in interest rates.
  • Governments announced the guarantee of the public’s deposits at banks.
  • Governments embarked on an aggressive program to recapitalize the tier one and tier two capital structures of banks.
  • Regulations banning or controlling short selling were rigorously reviewed. 
  • The IMF (International Monetary Fund) announced rescue plans for emerging economies.
  • Some counties initiated sovereign wealth funds to protect what they consider to be important companies.
  • The British and European central banks indicated that interest rates will be reduced further in the near future.

Never before had so many governments announced such a powerful concoction of stimulatory tools and arrangements simultaneously. While predicting the course of markets and economies remains hazardous to say the least, it may be fair to expect that these arrangements together may have a real effect on GDP growth and financial markets worldwide. In addition, lower oil and food prices together with sluggish consumer demand has changed the inflationary landscape in most countries.

It is against this background and that of the value that the market is currently offering, that we think it wise to start investing. Historically the equity market has provided excellent long term value in periods following these low earnings multiples.

The stock exchanges of emerging markets have been as negatively influenced, if not more  so, as those of developed markets although emerging markets have a number of economic characteristics that may be to their advantage during the next 18 to 24 months. It would also not be unreasonable to expect that the emerging economies are about to become much more important players in world trade and politics as a result of these advantages:

  • Since 1998 emerging markets have enjoyed much faster GDP growth (than developed markets).  In fact, the current growth rates are about 6% in emerging economies vs. about 1% in advanced economies. In addition, the emerging world’s population growth has tapered off during a period when GDP growth (per capita) has increased at more than twice that of the developed world.
  • Emerging economies have much less debt.
  • These economies hold large amounts of foreign reserves.
  • Inflation is no longer such a problem as in the beginning of 2008, with the consequence that inflation levels of emerging markets and that of developed markets have started to converge.
  • On balance there has been a strong positive capital and investment flow to emerging markets since 1995.
  • Emerging markets’ share of world trade increased from 27% in 1990 to 44% in 2008.
  • Future international purchasing (i.e. consumption) power will probably be more dependent on emerging countries with large populations coupled with stronger GDP growth.
  • Banks in important emerging markets like Brazil, Russia, India, China (the so called ‘BRIC countries’) as well as Turkey and South Africa, amongst others, are healthy and well capitalized. 
  • This will contribute much towards a smooth recovery process in the world’s financial markets.

The (not so) unreasonable conclusion that could now be drawn is that markets have reached, or are very near, to a bottom and that things will start to improve henceforth – especially so in emerging markets. 

Charles Snyman
021 410 6000
082 377 9335
Sources
Financial Times – various issues
Bloomberg – various news items
Franklin Templeton – Emerging Markets Review
Sarasin & Partners – Global Strategy