Now is the time to plunge back into muddy waters of SA equities
While current conditions seem treacherous, local shares will start to perk up
Are you one of the many SA investors who has reduced their long-term portfolio’s exposure to local equities in the past three years due to their poor performance? Perhaps you have switched from equities to cash or put all your new money into “lowrisk” cash investments?
If so, you may be pleased with your decision in the short term, since cash investments have returned 7.4% per annum for the three years to August 31 (as measured by the STeFI Index), while the FTSE/JSE All Share Index (Alsi) has returned only 4.7% per annum over the same period.
Yet, if you are a longer-term investor — perhaps investing for retirement — you should still be concerned, because these cash returns are unlikely to beat inflation sufficiently in the long term to give you enough capital growth over time. If you maintain a conservative approach and stay in cash, you are unlikely to build up a large enough retirement pot to meet your needs.
The reality is that at some point you will need to move back into SA equities and listed property, assets that have historically offered the requisite inflation-beating returns over time (averaging about 12-13% per annum).
So when do you buy more equities? History has demonstrated that most people wait until it’s too late.
They don’t want to invest in equities because historical returns have been poor — so they wait for the historical returns to improve first, and then move into equities. By definition, this means they miss out on a large part of the upside on offer.
The effect of missing out on the best five weeks of returns on the Alsi since February 2000 would mean investors who stayed consistently invested in the FTSE/JSE All Share Index would have received R677 from their R100 investment, but those who missed the best five weeks would have received only R379, an astounding 44% less.
Meanwhile, those who were exposed to cash over the entire period would have earned R415, which is 37% less than the equity investment.
After such a weak five-year performance, it should be no surprise that the SA equity market is trading at attractive valuations: as of August 31, the Alsi’s 12-month forward priceearnings ratio (PE) was at about 11.8 times. This represents discounts of 20%-25% compared to history, which were last at such a low level in early 2009.
Meanwhile, the Alsi’s pricebook value ratio is at 1.7 times, also the lowest since 2009 and much cheaper than its longerterm average of 2.2 times.
Though many investors are arguing that “this time it’s different”, the concerns over SA’s low growth, corruption and divisive politics are certainly nowhere near as threatening as the global financial crisis conditions were back in 2009.
Should all things remain the same with no increase in the PE multiple, Prudential estimates that equities are priced to deliver a return of about 14% over the next three to five years. However, if the PE multiple rises back to its historic longterm average and company earnings growth does not disappoint, then it could offer an even higher return.
This makes it a good time for those longer-term investors now sitting on cash to start getting back into the SA equity market.
Of course, we don’t know how or when these prospective returns will materialise, only that based on its past performance over decades, the equity market typically delivers excellent returns over the long term from such cheap valuation levels.
Investors wanting to achieve longer-term returns of 4%-5% above inflation should include about 40% equity exposure in their portfolios, typically found in more conservative balanced unit trusts.
For those aiming for 6%-7% above inflation, they would need up to 75% exposure to equities, which is offered by a typical balanced unit trust.
Don’t be dissuaded by the excessively pessimistic sentiment now prevailing that could lead to more equity downside in the short term; longer-term investors need to be in the market to capitalise on the upside.