Dear Rohan

I returned last night from my three week trip around theglobe and the world is a very different place to what it was before I left! I thought I’d pen this letter to you straight away because year end is fast approaching and I wanted to make this letter a priority.

POLITICS

I was privileged to be in the USA when Barack Obama was elected as their next president. The outcome of these elections will have a huge impact on the world. America remains, by a significant margin, the largest economy globally and as a result the most influential. Whoever is appointed there will still have a significant impact on all issues globally.

Although Obama has inherited a mess, he appears to bebuilding a very good team of people with vast experience capable of doing agood job (many of them held senior positions in the Clinton era). There is also a mix of new people in Obama’s administration with a fresh vision. From thevarious polls conducted in the USA, Obama has the highest expectations of anypresident elect in living memory (i.e. expectations on Reagan and Kennedy were lower than what is being expected of Obama). There is however a quiet confidence amongst many that he will achieve a great deal.

In South Africa the ANC breakaway party called Congress of the People (“COPE”) was started and I believe this is a very positive milestone in the evolution of democracy here. It is still too soon to see who and what the extent of their support base will be. The impact on the political, and thus
economic, future of SA cannot be underestimated by this move. It has also been welcomed by many as a positive step abroad.

ECONOMICS

The day before my departure I attended a presentation run by RMB Asset Management. In that presentation the very succinct point had been made that the world was in a banking crisis which, up to that point, was largely a “Wall Street” problem. Although very serious, RMB felt this problem would last 4-6 months as liquidity, and thus confidence amongst banks, would be restored through the various and significant fiscal initiatives being implemented globally. A lot of people were angry that a few American banks and investment banks had acted recklessly and had exported this risk globally - it had also become a global banking crisis. The concern was that the crisis which had been contained to financial institutions had the potential to turn into a global economic crisis too. If these banks failed and credit dried up, business could be seriously impacted.

The big question therefore at the end of October 2008 was: “Would a largely financial sector crisis spill over into the real economy?”

This was an important question because liquid cash, or liquidity, is the lifeblood of the global economy. If banks stopped lending to businesses, as they had stopped lending to each other, this would result in a significant contraction in real economic activity globally. We could suffer a recession or worse. If we were going down the path of an recession, what was the extent of the problem and how long will it take to recover?

It was with these questions in mind that I travelled the world speaking to hundreds of business people, stockbrokers, asset managers, hedge fund managers, and private bankers to find some answers.

After all the discussions, listening to the various commentators and reading various media I have concluded that the problem has moved out of the banking system and into the real economy. The extent of the problem is much worse than I thought it would be. People have fundamentally lost faith in the global banking system. Banks have seen their balance sheets shrink due to asset prices falling and this has had a major knock on effect. Many banks at this point are “defending their balance sheets” and are just trying to remain solvent. They are not interested in lending out any more money – they’ve leant out too much already!

In the past 20 years I have seen a number of economic crises.

The late 80’s saw the Savings and Loan meltdown in the USA and Japan’s economy peaked
at a never to be repeated high off the back of a massive credit and property bubble (sound familiar?). In the early 90’s there was a recession in the UK with a property crunch resulting in negative equity on many people’s home mortgages. Then there was the Russian bond crisis and the collapse of the Thai Baht. This had a huge impact on emerging markets referred to as the Asian Tigers and in South Africa our interest rates spiked up to 25%. Shortly after recovering from that, the world experienced the tech bubble with Y2K and then we had 9/11.

BUT all of these “crises” I liken to being in a serious car accident. We may have “broken a few bones” during these accidents but they were never potentially fatal. This economic crisis however is like having a heart attack. It is potentially fatal. The reason for this is that the banking system as a whole has been seriously damaged. And just like the heart, without the lifeblood of cash being pumped through the system, the system can fail.

On the positive side however, the 20 biggest nations have come together because they have recognized the seriousness of the situation. The G7 recognizes too that countries like Brazil, India, China, Mexico and South Africa all have a part to play in fixing the problem. China has pumped USD600bn into their economy and a total of USD10,000bn has been injected into economies and banks globally to date. This is unprecedented and it is why I don’t believe we are heading for a depression like the 1930’s. The last time the world saw economic cooperation
on this scale was shortly after WWII when the Bretton Woods Agreement was signed. Central bankers around the world are cognizant of what transpired in the 1930’s and the Great Depression and want to stave off a similar situation at any cost.

In addition, legislation will no doubt follow off the back of this crisis. Banks will be more tightly run as a result. Executives will have their bonuses paid out in a different way to stop them from “betting the bank”.

The system at the moment rewards too highly managers who risk the company’s assets in return for huge bonuses. It seems little has changed since Adam Smith wrote about the “agency problem” with company directors back in the 1800’s!

The other massively positive outcome is that South Africa has jumped up the ladder because of its fiscal prudence and conservative banking system. Africa’s banking system too has come through this crisis largely unscathed. Kenya’s banks reported an increase in profits of roughly 30% for the past year last week! As a result inward investment into Africa is likely to increase over the next 5 years as these economies will continue to grow organically and companies operating within these economies will prosper.

WHAT TO DO WITH YOUR INVESTMENTS?

So what do we do with our money right now? Make no mistake, the dilemma of what to do next is not confined to you! I read in the FT yesterday that all of the Endowment Funds for US Universities are down between 20% and 30%. That is significant, because most of the largest endowment funds have their own asset managers managing their funds. The best and brightest of the lot have struggled this past year.

In my view, and as I have said before, if you’re already  invested in the market this is the best time to rebalance and buy into the unprecedented lows on the stock markets globally. There are many very good companies trading at significant discounts to their net asset values and this is simply not sustainable. We should aim to emulate people who have made significant wealth out
of the markets like the Rothschilds, Sir John Templeton and Warren Buffett – we should buy when the markets are at their lows.

For those not in the market yet, it is impossible to know when the market will turn. Buffett even said he did not know if shares would be higher next week, next month or at the end of the year. So the best way to invest is to buy in small measured amounts frequently in order to average the costs.

For those who want to take a more conservative “wait and see” approach, there are investments offshore which are generating about 8% - 10% in USD right now in spite of the markets. This is a significant outperformance of cash in a bank or money market fund generating 1%.

If you would like to speak to me about your investment options please feel free to contact me.

I look forward to hearing from you.

Kind regards

Carl