The market’s never wrong
Dart thrower’s paradise for past three years
DART THROWERS have had a whale of a time over the past three years on the financial markets. Passive investment vehicles such as Satrix 40 clocked up returns of close to 40% in each of the past two years and the best performing fund of the year to February – Coronation Resources – logged a 58% return. It was almost impossible to lose money in a market where the underlying economy was growing at more than 5% (closer to 7% if imports and exports are excluded).
“The resilience of this market has surprised everyone,” says David Shapiro, manager of the Sasfin 2010 Fund, which invests in funds likely to benefit from infrastructural spending. “There were many people warning a year ago that the market was looking overheated, but if we have learned anything it’s that the market is never wrong.”
That resilience was tested in May last year when an emerging market scare toppled the JSE Alsi 40 index by 17%. The index bottomed out in June and then raced up a further 47%. Another speed wobble in February this year knocked the index by 7%, but investors saw that as just another opportunity to buy in at a lower price. By end-March the index had again broken new highs.
Even at these lofty levels analysts say the market is by no means over-priced, though you have to look harder for value. Industrial firms are expected to show earnings growth of 17% over the next year, slowing to around 9,5% thereafter, says Paul Hansen, director of retail investing at Stanlib. “Over time earnings growth tends to track the nominal growth in gross domestic product, and we believe the outlook for SA remains very positive.”
Much of that optimism comes from the expected R450bn in public sector infrastructure spending and a possible further R1 trillion from the private sector.
Eskom recently announced an almost 50% increase in its planned spending to R150bn to meet demand for power and to help pay for that it wants a substantial hike in electricity tariffs. Airports Company of SA has announced a near quadrupling in its capital spending budget leading up to 2010. That’s in addition to projects already under way, such as the Gautrain, as well as port, rail and road upgrades. Construction firms’ order books are chock-a-block and cement is being imported to ease SA’s supply bottlenecks.
The economy is firing on all cylinders and there are signs that the interest rate cycle is at or near a peak. Everyone has their eyes on 2010 and the fortunes to be made along the way. The problem is, much of that’s already priced into asset valuations though there are some sectors and individual stocks that have caught the eye of investors.
Banks are trading at price:earnings multiples of between 12 and 13, slightly below where they were a year ago. That isn’t out of line with the p:e ratios of European banks, currently enjoying a period of unprecedented growth.
A report by Mercer Oliver Wyman on the state of the world’s financial services industry notes that 21% of the growth of the world’s leading banks comes from emerging markets and that will grow to 40% within five years. That’s good news for SA, which has a vast potential market of unbanked customers yet to enter the mainstream. The black middle class is growing by an estimated 420 000/year, though the National Credit Act, soon to come into force, may rein in the lending spree that’s fuelled earnings growth over the past five years.
Many retail shares now look fully priced after more than trebling over the past three years, though there are still opportunities in selected stocks. Louis Stassen, chief investment officer at Coronation Asset Management, says Woolies, while not cheap, is gaining market share in its food division and that’s not fully priced into the share. Another investor favourite is Netcare, which broke the SA foreign acquisition curse by making a success of its British operation, General Healthcare Group.
One sector attracting huge interest is platinum. Anglo Platinum is up nearly fivefold since December 2004, a performance beaten only by Aquarius Platinum, up 7,7 over the same period. The seemingly absurd valuations applied to platinum stocks reflect the underlying health of the world vehicle market and demand for autocatalysts from environmentally sensitive vehicle makers worldwide. Massive investment is taking place across the Bushveld complex to meet future demand for platinum and in that light Anglo Platinum’s p:e ratio of 25 isn’t out of line with historical averages.
For all the good news there are some storm clouds gathering. The massive increase in infrastructure spending could put strain on SA’s balance of payments due to the high level of imports required to complete those projects. That in turn could hurt the rand exchange rate. The SA Reserve Bank is also tetchy over the rate of credit expansion, despite the two-percentage point increase in interest rates over the past nine months, with a further hike possibly on the cards at the next meeting of the Bank’s Monetary Policy Committee.
Saliegh Salaam, head of equities at Futuregrowth Asset Management, says that after four years of spectacular growth in which investors have become accustomed to compound annual growth of 38%/year they
have become less discriminating in their stock selections.
Says Salaam: “The so-called quality premium has disappeared. For example, transport company Imperial, which has one of the best earnings track records on the JSE over 20 years, is trading at a similar multiple to Super Group, which has had a more chequered earnings history. We believe that quality will reassert itself over time and that the convergence in ratings seen over the past few years may break down to reflect relative differences in quality.”
Salaam says at some point the JSE is likely to revert to its long-term average of 14%/year and now more than ever “careful stock selection is paramount”.
Another cause for concern is the valuation of the JSE relative to global stock markets, which has narrowed substantially in recent years.
Volatility is on the increase, there are doubts concerning SA’s ability to fund its current account deficit and inflationary pressures are building.
Shapiro agrees there are potential speed wobbles ahead, biggest of which is the danger that infrastructural spending will undershoot the planned targets due to a serious lack of capacity and skills. That may force Government to open SA’s borders to skilled immigrants.
The bears have now been urging caution for two years but nobody seems to be listening. They had the ears of investors in the aftermath of the 2002 crash, when prices dropped nearly 40%, but their gloomy predictions scared many investors away from a market that’s returned 243% since April 2003.
The prodigious and ongoing flow of cash into money market funds suggests many investors are either uncertain about the future direction of the market or they’re banking profits after the recent healthy run. Institutional fund managers were quick to spot the turn in the market in 2003, but individual investors – judging by the pusillanimous flow of funds into SA equity funds until 2005 – were late in spotting the equities boom.
Now that everyone seems to be jumping on board the equity train it may indeed be time to exercise caution. The economy may be in better shape than it’s been for two decades but Salaam dismisses the argument that “this time it’s different”.
“Those words – ‘this time its different’ – while possibly true, happen to be the most dangerous words in investing,” Shapiro says. He takes a more up-beat view, arguing that the multiplier effect of massive infrastructural spending hasn’t been priced into the market.
In other words, each R1 spent on Gautrain and Spoornet results in R3 or R4 additional spending as the economic benefits trickle down to suppliers, workers and their families.
The alacrity with which the markets rebounded from the sell-offs in February and May 2006 suggest investors are less prone to flee at each cry of wolf.
Any decline in prices is seen as an opportunity to re-enter the market at lower prices. There’s a fear that investors may fail to recognise real danger when it arrives, but for the moment the danger signs are distant to register.
The resilience of this market has surprised everyone. David Shapiro
The so-called quality premium has disap-
peared. Saliegh Salaam