Skip to main content

Market commentary May 2006

By May 2, 2006No Comments
SUMMARY. The commodity charts look worryingly like those for technology shares in 1999. Risks are rising. It is time to re-acquaint ourselves with investment basics, and the potential for sharp falls in higher risk investments.
Two interesting signals over the last month, tending to point us in the same direction.

China announced a rise in interest rates.  On its own it won’t slow down the Chinese economy much if at all, but it illustrates a clear intention on the part of the Chinese authorities to slow lending and investment spending in overheated sectors of the economy.  Wall Street wobbled, though has now regained its poise.

In the US, the Federal Reserve, in the guise of Ben Bernanke, surprised markets when he inferred that US rates would peak this month at 5%.  The textbooks say that bonds should respond positively to such news – they haven’t.  That is because the bond market thinks there is a good chance that Bernanke has got it wrong, that the US economy is continuing to improve, and that this will require even higher interest rates later in 2006.  Only time will tell who is correct

Both events indicate that risks are rising for investors.  Where last time we suggested that the seeds of market weakness are being sown, perhaps they are now beginning to germinate.

Last month we were very clear on the extent of the potential weakness in the UK, but it is much higher elsewhere.  The rise in some commodity prices has been parabolic, silver being a superb example, the asset for gamblers who can’t find enough excitement in gold.  Supply and demand for industrial metals obviously has a key impact on these prices, but it remains reasonably clear that speculation is the driver for recent moves into the stratosphere.  There might not be the mass participation that we regard as a key element of a true bubble, but if you lay a chart of industrial metals over one for the NASDAQ (representing technology) at the turn of the millennium, it is worrying.  The NASDAQ subsequently lost 78% of its value.

The greatest impact of a commodity price collapse will probably be felt in emerging market equities.  This will create a superb opportunity to build weightings in this area, where the long term picture is compelling (see January commentary), but before that point existing investors in these higher risk asset classes should re-acquaint themselves with investment basics.  The prospect of higher than deposit account returns arises because you are taking a risk with your capital.  The higher the prospective, and actual returns, the greater are the risks.  In higher risk asset classes (e.g. commodities and emerging markets) you must assume that occasional years of 100%+ returns will be balanced by others with 50%+ losses.  You never get poor by banking a profit.

Dennehy Wealth