It's a tight two-step: Alphen

Mark Cliff of Alphen Asset Management writes that this week will mark the end of June, the mid-point in our little sideshow called the FIFA 2010 World Cup and the end of the first half of the year or what we in finance call H12010

So where do we find ourselves in this random walk through the year? Let's take a look at two graphs which tell most of the story of 2010 so far.

The ALSI

At the start of 2010 the local All Share Index had risen by more than 20% off its then low of November 2009.  Many investors were wondering if this was the start of some sort of recovery but there remained a significant group of sceptics - both locally and globally - as to the strength of this rally. These fears were well founded over the short-term as January into early February saw a significant retreat in equity markets both at home and abroad.

The graph below shows the performance of the ALSI relative to the S&P500 - both in US dollar terms in order to strip-out the effects of currency fluctuations.

As should be clear from this graph, there has been a significant correlation between the performance of the US market and our local one. It is also significant that when the markets have fallen, our resource-based market has tended to fall quite a bit further than the US, but when the markets correct, the rallies have been primarily led by the resources again. Notably, this has been a very volatile period for the markets with a drop in the Domestic Index of nearly 16% between the start of the year and early March followed by a rise of no less than 63% to mid-April followed by another drop of nearly 12% to early June.

The Rand

The second graph below shows the dollar/rand exchange rate and the Volatility Index (the VIX). This graph shows the period from the start of 2009. The VIX, you will recall, is a measure of the price of insuring against volatility and is essentially a measure of risk appetite. When the cost of insuring against risk is low, there is a high appetite for risk and vice versa.

Again, there is an obvious high correlation between the movement in the VIX and the relative strength or weakness of our local currency. Clearly, as global risk attitude increases, so to does the demand for rands as money flows in to purchase our assets and when global risk attitude decreases, demand for dollars increases and the value of the rand falls.

So what does this tell us about markets and the rand going forward?

At PSG Alphen Asset Management we believe that for so long as there is a global appetite for risk, we will see domestic equity markets moving into positive territory and a relatively strong rand. In an environment of historically very low interest rates and a continuing policy of maintaining global liquidity this will be positive for our domestic exchange and will tend to keep a relatively strong rand. As we have highlighted for some months now, risks abound in many global markets - equity and otherwise - and further volatility can be anticipated. For how long this may continue for is anyone's guess. We are constantly looking for opportunities to buy quality companies at good prices whilst at the same time avoiding those stocks which appear to pose a risk of permanent capital loss.

The Alphen Angle is an electronic newsletter of PSG Alphen Asset Management. To read more about PSG Alphen please go to AlphenAM.co.za.