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November 20, 2008

Economic Woes Torpedo Stock Markets
by Prieur du Plessis

Yesterday was another ugly day for stocks, with bourses around the globe falling victim to strong selling pressure. Fueling the sell-off were concerns that the economic recession could not only be deeper and longer than previously feared, but also fall into a corrosive deflationary phase.

The MSCI World Index and the MSCI Emerging Markets Index fell by 4.6% and 2.2% respectively, tallying declines of 51.2% and 63.4% since the peaks of these indices in October 2007. Only the Chinese Shanghai Composite Index (+6.0%) and the Russian Trading System Index (+0.7%) bucked yesterday's declines.

A (very red) market map, obtained from Finviz, providing a quick overview of the performance of global stock markets (as reflected by the movements of ADR stocks).

As far as the US markets are concerned, the Dow Jones Industrial Index (-5.1%) plunged below the roundophobia 8,000 level, resulting in all the major indices now trading below the recent lows of October 10 and 27. This brings the lows of 2003 (Dow 7,524; S&P 500 801) and 2002 (Dow 7,286; S&P 500 777) into sight. A breach of these levels - frightfully close to the current levels of the Dow (7,997) and S&P 500 (807) - will wipe out the entire five-year bull market from 2002 to 2007.

Interestingly, only 2.4% of the 500 S&P 500 stocks now trade above their 200-day moving averages. This line is often used as a crude indicator of the primary trend of a market or individual stocks. The graph undeniably shows an extremely oversold situation, but bear markets have been known to stay oversold much longer than usual.

One can argue long and hard about valuation levels and earnings forecasts, but the extent to which stocks become undervalued in the grip of this bear is squarely in the hand of the severity of the economic meltdown. This is clearly shown by the relationship between the Dow Jones World Index and the Baltic Dry Index - an assessment of the price of moving the major raw materials, including coal, iron ore and grain, by sea and generally an excellent barometer of economic activity.

The worrisome prospects for economic and earnings growth, together with the threat of deflation, are spooking the financial markets. The extreme level of risk aversion is illustrated by the US three-month Treasury Bill rate falling to a minuscule 0.065% - a clear sign of distress and fear - and the yields on long-dated government bonds falling significantly in most parts of the world.

Here is what Richard Russell (Dow Theory Letters) - one of the few market commentators with first-hand experience of the Great Depression - has to say: "The market is warning of a coming depression. Next year there'll be a huge problem of unemployment, job openings will have disappeared, and every business will be going over its personal thinking in terms of who the business can do without.

"The sentiment in the country will be dark grey to jet black. Fortunes will have been wiped out. Thousands of savings plans and 401Ks will have been shattered. Americans who have never experienced true hard times will be living hard times. Confusion and fear will be rampant. How do I know all this? I've been here before, I know the signs."

Oversold conditions have so far not produced more than a temporary reprieve, and nobody knows how far down this bear market will fall. Until we see more signs of base formations being developed, one should tread very cautiously. And remember the old Boy Scout adage: "Be prepared".

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Dr Prieur du Plessis
investmentpostcards.com

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

Copyright © 2008-2009 Dr Prieur du Plessis

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