Shape of JSE means go active or go home

To understand the performance of the JSE better, it helps to divide it into four parts: local economy plays, global plays, resource companies and, in an important category of its own, Naspers.

The banks, retailers and many of the listed small and mid caps depend on the South African economy. They perform better when the rand strengthens unexpectedly, inflation and interest rates come down and spending by households and companies gathers momentum.

The global consumer and property companies depend on the expected state of economies outside SA. Their share prices in dollars are determined mostly by investors offshore and then translated back into their rand equivalents at prevailing rates of exchange. Given the dollar value of their shares, the rand values go up and down as the rand weakens or strengthens.

However, their dollar values may also be changing. The better their expected performance, the more valuable they become in dollars, and vice versa, translated almost simultaneously into rand values. Therefore, higher dollar values for such stocks may well overcome rand strength and lower dollar values may even drag down their rand values, even should the rand weaken at the same time. They may not act as rand hedges.

Specific South African forces as well as global forces with little to do with SA can weaken or strengthen the rand. These global plays tend to perform best in rand when rand weakness, for South African reasons, accompanies good global growth and improving global equity trends. When the rand strengthens for South African reasons, the opposite may happen. Their rand values can decline, as they have done since 2017, even as global stock markets move higher. They are thus better regarded as South African rather than rand hedges.

Since January 2017, an equally weighted basket of 18 South African plays has gained about 24% in value and the 13 equally weighted global plays have lost 13%. The JSE as a whole, subject to these opposite forces, went up about 14%, helped by the gains by Naspers and resource companies. The JSE’s resource companies earn their revenue on world markets in dollars. Some of their production is costed in rand. A weak rand is helpful to their revenues and may help widen their operating profit margins should rand costs lag behind rand revenues.

However, a weaker rand and weaker emerging market currencies may well be associated with weaker global growth, lower metal prices and lower share prices in dollars.

This was the case at the end of the super commodity cycle in 2011, and lasted until mid-2016 when the weaker rand could not make up for these lower dollar values. JSE-listed resource companies were not rand hedges over this period — their rand values declined with the weaker rand.

And now Naspers, with its large holding in Tencent, an extraordinarily successful Chinese technology company. The rand value of Naspers shares tracks the rising value of its Tencent shares enough to make it the largest company on the JSE. Without Naspers, the JSE as a whole would be worth no more today than in 2014. The JSE all-share index has become a part play on only one company.

Most companies listed on the JSE will do outstandingly well when met with a surprising rand strength plus surprising strength in the global economy, associated as it will be with surprising improvements in metal prices. And the JSE will do even better should Tencent and global technology continue to surprise investors with their results. The potential upside and the potential dangers call for active, sector-biased investors.

The risks to investors on the JSE are too concentrated to justify a passive approach.

Kantor is chief economist and strategist at Investec Wealth & Investment. He writes in his personal capacity.