The sharp sell-off in the world's major stockmarkets in recent weeks is likely to result in October 2008 recording the worst monthly performance ever. Various international columnists have written about the reasons behind these sharp losses as the effects of the credit crises caused widespread concern on the length of a global recession and its impact on corporate profitability. However, the behaviour of investors during these historic moments is another aspect worth mentioning.

The coordinated rate cuts by many Central Banks on October 8 in a bid to restore confidence failed to calm investors. Equity positions continued to be sold off indiscriminately irrespective of company fundamentals as some investors sought safe havens for their hard-earned savings. The flight to safety can be easily noticed by the sharp decline in the yield on US Government Treasury Bills. This dropped to a fraction of a percent in recent weeks implying that investors are willing to earn virtually no return just to be assured that their money is safe and can count on having it back when they want to.

While some investors concentrated on placing funds in Treasury Bills to escape the turmoil in the equity market, others looked at the sharp sell-off in global stockmarkets as a buying opportunity since share prices of several companies have been unduly punished by forced-sellers, notably hedge funds.

Warren Buffet, the legendary investor, was always guided by a strategy to "be fearful when others are greedy and greedy when others are fearful". Mr Buffet's philosophy was always one of a strategic or value investor as opposed to a trader.

When following a strategic investing approach, investors ignore daily share price movements, and concentrate on buying into a company's future profits at low prices. Over the longer-term, share prices tend to reflect the progress of a company's profits.

On the other hand, when investors adopt a trading strategy, selling (or buying) is completely unrelated to fundamentals: people sell (or buy) just because they feel the market will continue dropping (or climbing). While the recent sharp sell-off was induced by the real problems in financial markets and the recessionary effects on company's profitability levels in the future, stockmarkets invariably overshoot or undershoot as investors behave irrationally. In fact, while many would think that the banking sector has seen the steepest declines, energy and mining companies have performed worse. Although commodity prices have declined substantially from their peaks, many energy and mining companies are still making substantial profits (sometimes as high as their current market cap), while on the other hand banks are suffering heavy losses and require fresh capital.

Markets therefore act indiscriminately and some of the best investments can be made by buying best-of-breed companies during periods of general market turmoil and holding them until the market comes back to its senses. In fact, Warren Buffet has recently invested a portion of the large cash holdings of his public company, Berkshire Hathaway, by acquiring sizeable stakes in General Electric and Goldman Sachs. Moreover on October 17, in a column on the New York Times entitled "Buy American... I Am", Warren Buffet stated that even on his own personal portfolio he has started to shift out of US Government bonds into equities. The world's most renowned value investor claims that although he cannot predict the short-term movements of the stock market (in fact since then markets have continued to drop), "the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up".

The credit crunch has also created buying opportunities for bond investors with some high-quality corporate bonds yielding unprecedented premiums over Government bonds. Spreads between investment-grade bonds and Government bonds have widened to more than 500 basis points in recent weeks compared to normal spreads of around 100 basis points. At a time when major central banks are expected to continue to cut interest rates, some bond yields look extremely attractive especially when returns on Treasury bills and bank deposits are likely to be falling in the months ahead.

On the local equity market, some investors have also behaved in a similar fashion to those in international markets placing increased selling pressure across most of the publicly quoted companies. However trading activity has shrunk as buyers retreated, possibly placing funds temporarily in the Treasury Bill market ahead of potentially more-rewarding buying opportunities in some of the equities. Trading activity also waned as investors became increasingly nervous about the impact of the investment write-downs to be taken by Bank of Valletta on its overseas bond portfolio. BOV's much-anticipated September 2008 full-year results will be published tomorrow and the extent of these write-downs on the Group's overall profitability as well as the amount of the final dividend to be recommended at the next Annual General Meeting are key factors that could impact not only BOV's share price performance, but the overall direction of the entire market. Many local commentators have been rightly proclaiming that the local banks should not be affected in the same way as those in other countries due to the conservative nature of our banking industry. Local banks finance their operations almost entirely from domestic deposits, unlike the foreign banks which depend heavily on the inter-bank market. Many international banks have highly leveraged positions with loans to deposits ratio exceeding the 120 per cent level. The reassuring healthy situation of the local banking system is likely to entice Malta residents to repatriate funds held in overseas banks and provide added liquidity to the already-robust local financial system. Should this materialise, the local banks could emerge from the current international banking crisis on an even stronger footing. This is further supported by a recent report issued by the World Economic Forum on the local banking industry, which claims that Malta has the world's 10th soundest banking system, well above the rankings of the UK, the US and Germany.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, "RFC", are members of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

© 2008 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved

Mr Rizzo is director of Rizzo, Farrugia & Co. (Stockbrokers) Ltd.


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