DR. JIM LEONTIADES
Cyprus International Institute of Management
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Recent stock market volatility on both sides of the Atlantic has been formidable. The sub-prime crisis in America may have triggered the downturn in share prices but the impact has gone far beyond its origins. Dramatic losses in some major banks and mortgage companies were highlighted prominently by the world press, initiating a frenzy of speculation on possible future corporate losses and share price disasters. The reaction of many investors to this media circus can only be described as a “panic”, an overreaction with only a tenuous connection to reality.
The panic was quick to spread worldwide. Losses on Wall Street were quickly reflected in Europe, Korea, Japan, Hong Kong, China and India. In India, authorities had to temporarily close the stock exchange to limit price falls. However, the center of the storm remained in New York’s Wall Street. There, IBM (a traditional market leader) reported earnings which exceeded the most optimistic expectations. The stock market reacted to the good news by falling sharply. The Apple Computer Company followed IBM, reporting record earnings which again beat expectations while forecasting a 29% increase in sales for the next quarter. The market dropped still further.
The bad news on the stock market quickly spread to the general economy. The chief Economist of a prestigious American think tank responded by speculating that the American economy could go into “a free fall”. Other analysts predicted foreign investors would flee. Still others foresaw foreigners buying up major parts of American industry. A further major devaluation of the dollar was declared a distinct possibility.
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Official Action
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On the official front, the American Federal Reserve broke its usual procedure and rushed to announce a massive three quarters of a percent reduction in interest rates. At first, share prices responded positively, but there were reservations. Did the American Federal Reserve do the right thing by lowering the interest rate by so much all at once? Many said the reduction was not enough. Others said it was too much. Some viewed it as confirmation that the Federal Reserve felt the economy was in even worse shape than reported. Respected economists warned that the Fed’s action would result in future inflation.
The American government followed up with a proposal for new tax legislation designed to stimulate the economy. Prices on share markets rose sharply. Political opposition to the proposed tax cuts emerged. Share prices plummeted. A day or so later they fell in the morning only to turn around for a net gain of 300 points on the Dow Jones index the same day.
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Cyprus and the Crowd
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Here in Cyprus the ups and downs of Wall Street were typically reflected in our local XAK. If anything, share price variations here were even more extreme then those in
However, it is wrong to jump to the conclusion that we are completely insulated from such events. In an increasingly globalized world -a major impact in one part of the world will be felt elsewhere, even in Cyprus. Though this does not mean it will be felt to the same degree. There is little reason to feel that a recession in the United States or Germany, etc., will bring about a recession here, even though the economy may slow somewhat and some businesses could be effected adversely.
In Cyprus companies are still projecting strong earnings. Fitch and Moody’s, the two major rating agencies, are very positive about the Cyprus economy. Major foreign banks, such as DB and USB, have repeatedly said that they favour the shares of the major Cypriot banks. Cypriot investors with close knowledge of Cypriot company performance are buying. The number of insiders purchasing shares on the XAK during the last few weeks greatly exceeds those selling. Shacolas is offering to buy all of CTC.
Are they right? Who knows? It is a fact that following the crowd is not a very profitable strategy. Shares purchased when everyone is optimistic are likely to be fully priced with little scope for a price increase. On the other hand, some see market panics as an opportunity. When everyone is selling share prices are often undervalued. Warren Buffett in Omaha, far from the hype of Wall Street, is buying. The world’s most successful investor has just placed many millions in railroads and insurance companies.
History tells us that share prices both rise and fall. Reviewing the performance of shares over the last 80 years (as indicated in the Standard & Poors 500) reveals many occasions when prices fell, sometimes even more steeply than the recent decline. However, the index also shows that such drops were invariably followed by a recovery. The long term trend of such prices is clearly upward. Over this 80 year period share prices have averaged an increase close to 10% annually. That should be a comfort to long term investors. As for the short term, it is foolish to make market predictions, either pessimistic or optimistic.
