Market Trends and their Predictions for the Future

Should You Rely on Market Trends?

An article published in Business Day has drawn attention to market sentiment, suggesting that it may not be as reliable a short-term barometer as many investment commentators seem to think.

Apparently, the favoured test of its accuracy is the future correlation of share prices and the growth of earnings. If the market trend happens to change, this indicates that much the same trend will occur with companies’ investment fundamentals.

Ben Temkin, author of the article in Business Day, is not convinced that this is the case. Over the years, he has noticed that a bull trend ends when shares are overbought and vice versa. This kind of situation, he says, is not only true of shares, but also the residential property market, where house prices kept rising as long as demand met supply. When it suddenly became evident that supply was outdoing demand (which in the stock market would mean that shares are overbought), prices began to stick at first and then fall.

The residential property market is in a bear trend now, but it didn’t become a bear trend ahead of the hike in interest rates. In fact, house price levels were resistant to interest rates for quite some time.

Even more interesting to note is the fact that the line chart of the JSE electronics and electrical index has had (over the past two years), almost the same shape as the JSE real estate index. If the barometer thesis is to be followed, this would mean that the current weakness in the JSE real estate index is a warning that a bear market in commercial and industrial property is expected and there should be significant falls in earnings in the affiliated companies in the electronics and industrial index.

Temkin can accept that the supply of office, retail and factory space can, or already has, overtaken demand because of the current economic slowdown. However, he finds it much more difficult to believe that the demand for infrastructural growth is suddenly to going to slow down and drastically stunt the growth of Altech and Reunert, as the barometer would suggest.

In his experience of the stock market, Temkin has seen that a change in its trend does not necessarily signal good or bad news. However, it does tell us when good or bad news has been digested and that this process can often be uncomfortable, which pushes the trend too far and too fast.

Temkin goes on to describe the market as a crowd, using the recent example of crowd behaviour in Sasol’s share price trend. For obvious reasons, Sasol’s share price is correlated with the price in oil. The crowd often tends to forget though that Sasol is not only about oil. The Private Investor portfolio bought shares in Sasol in December at R315.70 and the oil price was then just $95 a barrel.

When the oil price peaked at $140 towards the end of last month, Sasol’s share price hit the roof at R506 in May, which was well before the peak in the oil price. Currently, oil is priced around $125, which is 10% below its peak and Sasol’s share price is about R400, 20% below its peak. This merely proves the market lied on Sasol’s way up or is lying now. The point here is that you cannot rely on market sentiment to be an early warning sign of future investment fundamentals, which obviously include plenty of gambling.

The information in this article is courtesy of Ben Temkin (“South Africa: Market Trends Not That Reliable”, Business Day, 30 July 2008).

Visit www.sahometraders.co.za if you would like to buy or sell property in South Africa.