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Spread the risk when expecting the unexpected






Every now and then events take place that we never expect. The unpleasant ones we label “shocks” but the more pleasing ones we usually term “surprises”. Winning the fifth one day cricket international against the Australians after they had posted a world record total was a huge but extremely pleasing surprise. For the Aussies it was undoubtedly a big shock. Some shocks are highly distressing and many people, for example, can tell you exactly what they were doing when they first learnt of the assassination of John F. Kennedy or the tragic death of Princess Diana or where they were when they watched the drama of the Twin Towers unfold on TV. As with life, the markets are also prone to shocks and surprises. More recent examples include the 1998 emerging market crisis, the bursting of the IT bubble in 2000, the market reaction to the terrorist events of 2001 and the dramatic rand depreciation in the same year. The emerging markets crisis had its greatest impact on the interest rate markets. In mid April 1998 government’s benchmark R153 bond was trading at a yield of 12,6%. By early August it had risen to 15,5% and three weeks later it breached 20,0%. On one particular day, the R153 yield gained more than 100 basis points, the magnitude of the yield range of the R153 over this past year! The prime lending rate was also dramatically adjusted at that time and many will remember how they fretted about meeting substantially higher monthly mortgage payments. Thankfully the fallout was short-lived and the markets soon recovered. Investors long of IT stocks at the end of the first quarter of 2000 will need no reminding of how the value of their investments was decimated in quick time. The riches to rags story of the Didata share price also needs no repeating but one particular IT stock incident stands out from that time. Warrants were just gaining popularity and the market was being introduced to an even more sophisticated product, barrier warrants. The gist of these warrants was that should the unthinkable happen and the stock reached its lower barrier, around half of its spot price at issue, the warrant would expire worthless. With IT stocks very much in play, barrier warrants were issued on, amongst others, Datatec. In early March Datatec was trading at R145 and this reduced to R115 at the start of the next month. Just two weeks later Datatec closed at R43.50 and the newly issued barrier warrants hadn’t lasted a week. That’s not a slight on the derivatives markets but the anecdote highlights the shocking collapse of the market at that time. Not many will forget the rand collapse in 2001 either when the currency moved from R7,50/$ in June to R9,00/$ at end-September and then to R10,27/$ at end-November and R13,72/$ on 20 December. Oil price shocks and the gold price spike to $850/oz also stand out clearly on long-term charts. The thing about shocks is that you can’t fully prepare for them. When investing though, one can carefully consider potential market risks and take some precautionary action. The best measure of insurance is diversification and the shrewd investor will not keep all of those proverbial eggs in the same basket. Diversify your investments, not only across the number of shares that you own or the sectors of those shares, but also across asset classes, across the geographic location of those investments as well as the currencies in which they are denominated. This will surely help should your investments ever have to face that unexpected market tsunami.
Source: Craig Pheiffer, Chief Investment Strategist
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