A Balloon Ready To Pop

Most global markets have had a good run since February this year.

They have been overbought and looked just like a balloon that needed an excuse to pop to bring share prices back to more realistic levels. The JSE Overall Index, for example has traded at a PE ratio of 18.48 recently. Maybe it was the culmination of currency volatility over Greece’s debt problems and a fraud case against one of Wall Street’s iconic investment banks that acted together to send investors looking for less-riskier pastures. A fraud case that the US Securities and Exchange Commission (SEC) has filed against the iconic Wall Street investment bank has raised the possibility that the financial crisis was caused not just by greed or stupidity, nor just by excessive risk-taking or poor regulation, but by old-fashioned fraud and deception. But the rules are not clear, and this is a whole new source of uncertainty about banks and their products. The charges against Goldman will also strengthen the hand of those who want much tougher regulation, of any and all derivative products that banks sell. That will make life tougher for banks. But the regulation was coming anyway. And it is no fail-safe remedy: those who are determined to perpetrate fraud will find new ways of doing it anyway.

An investment bank is a financial institution that assists companies and governments in raising capital by underwriting and acting as the agent in the issuance of securities. An investment bank also assists companies involved in mergers and acquisitions, etc. They also provide ancillary services such as market making and the trading of derivatives, fixed income instruments, foreign exchange, commodity, and equity securities. Unlike commercial banks and retail banks, investment banks do not take deposits. Investec, for example, is an international, specialist banking group that provides a distinctive range of financial products and services to a niche client base in three principal markets, namely the United Kingdom, South Africa, and Australia. Investec’s investment banking division, contributed 12% to operating profit as fewer transactions were closed in comparison to the prior year and commissions were impacted by lower volumes.

Investec is an excellent company with solid management skills and an impressive track record. The group has a wide geographic spread, diverse business portfolios and conservative risk management which have proven itself during the current turmoil. Shareholders are reminded that the state of financial markets has a significant influence on the performance of the company and in light of the current uncertainty prevailing in world financial markets, earnings growth visibility is extremely poor. We feel that the share is fairly valued trading on a rolling PE ratio of 9.7 times and a 30% premium to its NAV. Due to uncertain short term prospects across the industry, we would only recommend long term investors to continue holding the share.

Looking at the chart of Investec, we can see how the share price has moved from its lows in March last year to the recent highs in March this year. Although the trend is still bullish because it is trading above its moving averages, as well as the upward sloping support trend line, the share price has formed a double-top reversal pattern at 6550c. The share price should pull back from here and test the previous support level around 5300c. Wait for the balloon to pop first but at least you will not get a fright with the bang!