The article below originally appears in Financial Mail's supplement Fund Management (7 March 2008)

At the start of 2008, sentiment amongst equity investors is skittish. Whilst the source of this anxiety can be traced back to the subprime crisis in the US, a cocktail of factors has emerged since the middle part of last year that has cast shadows on the outlook for company profits, rendering equities less attractive. Amongst other things, these factors include a housing meltdown in the US; the related credit crisis and associated capital write offs by financial institutions in North America, Europe and the UK; and growing evidence of economic slowdown in the world’s leading economies, most notably the US, Japan and Europe. The weaker economic environment has also become bedeviled by high commodity prices, with platinum and gold achieving their highest ever prices in January, and oil threatening to breach the USD100-per-barrel mark, which has weighed on investors' minds. Similarly, in currency markets the record lows achieved by the USD have contributed to investors’ elevated anxiety.

Central banks have responded to the above forces by easing conditions in credit markets to support economic activity. Still, fear of economic recession and the spectre of stubborn price inflation have played a more dominant role, resulting in a weakened equity price environment. As evidence of this, the last two months of 2007 saw the world equity index lose five percent in USD terms, and equity returns in January represent the worst start to the year since 1982.

In addition to the above global forces, South African equities have their own demons to deal with. Contrary to the global trend, domestic interest rates have been rising to counter increasing price inflation, growth in consumer spending has capitulated, vehicles sales have slumped, the housing market is in decline, business confidence recently touched a multi-year low and the economic outlook has become clouded by political uncertainty. Unsurprisingly, given the buoyancy in commodity prices, the dominant resources sector of the Johannesburg Stock Exchange has proved resilient. However, financial and industrial stocks have come under intense pressure, particularly interest-sensitive counters, such as the banks, furniture retailers and other credit retailers. The net result was a seven percent decline in equity prices in Rand terms during the last two months of 2007, with weakness spilling into January in sympathy with the global trend.

Against the notably downbeat backdrop for companies, stock valuations have started to become far more varied than has been the case in the past few years. In turn, this dispersion in valuation presents an exceptional opportunity for far-sighted investors who are disinterested in the tail chasing activity that tends to dominate the investment environment. As Andre Oscar Wallenberg, founder of the hugely successful Swedish firm Investor AB noted: “It’s in bad times when good deals are struck.”

Examples of industries where stock prices have become particularly distressed include real estate in Japan, the US and Europe; building and construction in the US and parts of Europe; retailers in the UK; and financial stocks in the US. Using the last case to illustrate the extent to which prices have become depressed, amongst the largest banks and lenders in the US, including Bank of America, Citigroup, Fannie Mae, Freddie Mac, Wells Fargo, US Bancorp and JP Morgan Chase, dividend yields have risen to as high as seven percent, the entities trade on single digit price-earnings ratios and sit on price-to-book ratios that are at the lowest level they have been in the past 40 years, a period that includes the Savings and Loan crisis of the 1980s which saw more than 1 000 lenders in the US fail at a cost estimated to be in excess of USD150 billion. On this basis, it seems fair to conclude that investors have panicked, and that this has resulted in extremely depressed prices in places.

In a similar vein, the domestic equity landscape has seen growing dispersion in valuations, with interest-sensitive counters, such as retailers and banks, now trading on single digit price-earnings ratios and offering dividend yields that are, in places, as much as two-and-a-half times higher than the market average. Certainly, the near-term outlook for companies in these sectors is poor, but conditions will improve. Consequently, truly great companies will produce outstanding long-term returns, regardless of the political climate, the latest move in lending rates, or when the US housing market recovers.

Thus, investors who are able to see through the murk of the extant environment are being presented with an unusual opportunity to find some particularly inexpensive stocks in already cheap sectors and, in buying these counters with a patient outlook, will strike some great deals.