Are we headed for a bear mar­ket or sim­ply a cor­rec­tion?

The JSE has reached new records for the past two weeks and cur­rently trades around the 55 000 mark. In such an up­beat en­vi­ron­ment in­vestors should be cau­tious not to over­pay for stocks and guard them­selves against fu­ture slumps.

Finweek English Edition - - INSIDE - BY LIESL PEYPER

The JSE is cur­rently steam­ing ahead, reach­ing one record high af­ter an­other. But fi­nan­cial mar­kets fluc­tu­ate by na­ture, and sooner or later the JSE will begin to lose mo­men­tum and th­ese record highs will be­come noth­ing but a dis­tant mem­ory.


Fi­nan­cial an­a­lysts con­cur that the JSE is ex­pen­sive, es­pe­cially com­pared to other stock mar­kets around the world. “If we look at the JSE rel­a­tive to its own his­tory, the mar­ket is very ex­pen­sive,” says An­drew Newell, head of busi­ness devel­op­ment at Can­non As­set Man­agers. “This holds true across a range of met­rics, in­clud­ing price-to-earn­ings (P/E) and price-to-book ra­tios.

“Hav­ing said that, this does not nec­es­sar­ily mean that the JSE will cor­rect any­time soon,” says Newell. “It has been this way for some time, and, as we know, mar­kets can al­ways get more ex­pen­sive.”

Two im­por­tant un­der­ly­ing fac­tors that de­ter­mine the value of any share mar­ket are es­ti­mated earn­ings and pre­vail­ing in­ter­est rates over the short and long term. “A mar­ket can be ex­pen­sive as long as the fu­ture out­look sup­ports the eval­u­a­tion,” says Wayne McCur­rie, port­fo­lio manager at Mo­men­tum Wealth Man­age­ment. “The earn­ings out­look for the South African mar­ket is rea­son­able, es­pe­cially in rand terms. So there shouldn’t be any threat to our

mar­ket from dis­ap­point­ing earn­ings over the next two years or so.”

Lower in­ter­est rates lend great sup­port to eq­uity mar­kets and they’re likely to re­main low for the rest of 2015, lo­cally and glob­ally, says McCur­rie. In the cur­rent low in­ter­est rate en­vi­ron­ment the mar­ket is un­likely to col­lapse.

More­over, inf la­tion is un­der con­trol and there is no sign of an im­mi­nent re­ces­sion. “If any­thing,” says Gra­ham Bell, strate­gist at Old Mu­tual Eq­ui­ties, “the econ­omy is pick­ing up steam. The low in­ter­est rate en­vi­ron­ment is a prob­lem for in­vestors with cash, as they don’t get good re­turns in the cash or bond mar­kets, so they push down the risk curve, look­ing for riskier prod­ucts that will give a bet­ter re­turn.”

He says: “Eq­ui­ties are at­trac­tive in such an en­vi­ron­ment, as com­pa­nies are the most f lex­i­ble in­vest­ment ve­hi­cles. Peo­ple who run com­pa­nies are also very re­spon­sive to mar­ket con­di­tions and they can change the busi­ness or the man­age­ment quickly.”


While things are still look­ing up for stocks, there are a few ‘ca­naries in the coalmine’ that could in­di­cate the on­set of a bear mar­ket. “The pri­mary thing that would be cause for con­cern is if in­ter­est rates glob­ally start go­ing up much faster than ex­pected,” says Rhyn­hardt Roodt, head of the In­vestec Eq­uity Fund.

“It’s not so much the start of a rate hike, but rather the pace of it that is a warn­ing sign. Rates tend to go up quickly when economies are over­heat­ing, and economies over­heat when global inf la­tion is get­ting out of hand, lev­els of cap­i­tal ex­pen­di­ture are el­e­vated and busi­nesses are over-con­fi­dent. We don’t see that cur­rently.”

There will be some mar­ket cor­rec­tion, though, Roodt says. “Re­turns will be lower and prices will be more volatile, but as long as in­ter­est rate hikes are ac­com­pa­nied by a strong, ro­bust growth en­vi­ron­ment and favourable liq­uid­ity it will be okay. Money needs to find a home and there aren’t many al­ter­na­tives.”


The gen­eral con­sen­sus is there­fore that eq­ui­ties will yield good re­turns for some time to come. How­ever, fund man­agers warn that in­vestors should avoid ar­eas of the mar­ket that are over­priced.

“We don’t in­vest in stocks with trade above their in­trin­sic value and where there is a high risk of cap­i­tal loss,” says

Pa­trice Ras­sou, head of eq­uity at San­lam In­vest­ment Man­age­ment.

Can­non’s Newell agrees: “By def­i­ni­tion, a run in a mar­ket im­plies that shares be­come too ex­pen­sive. Make sure you don’t over­pay for stocks. Buy­ing eq­ui­ties at the right price will help to pro­tect your port­fo­lio.”

Duane Ca­ble, head of SA Eq­ui­ties at Coro­na­tion, re­it­er­ates this, say­ing that the South African eq­uity mar­ket is be­com­ing in­creas­ingly dis­lo­cated. “The mar­ket is in­creas­ingly pre­pared to pay any price for good busi­nesses with good prospects and is in­creas­ingly in­dif­fer­ent to the low val­u­a­tions for poorer-qual­ity busi­nesses with weak short-ter m prospects,” he says. “Pay­ing too much, even for a good busi­ness, can crip­ple your fu­ture re­turns. It’s there­fore im­por­tant to re­main dis­ci­plined in your as­sess­ment of longer-term val­u­a­tions.”


In the event of a mar­ket cor­rec­tion, it is best not to be over­ex­posed to eq­uity, says Mo­men­tum Wealth’s McCur­rie. “Make sure you are di­ver­si­fied. This is the only free lunch in in­vest­ments. And if you’re for­tu­nate to have some of the big win­ners of the last few years, sell some. They’ll be hard­est hit if we have a bear mar­ket.”

Dun­can Ar­tus, port­fo­lio manager at Al­lan Gray, be­lieves that the value of cash is cur­rently un­der­stated. “No one likes cash at the mo­ment be­cause of the lower re­turns, but we have a higher cash por­tion in our port­fo­lio. While it hurts in the short term as in­ter­est rates are low, peo­ple don’t take into ac­count that cash can be used to buy cheaper stocks.”

Coro­na­tion’s Ca­ble agrees: “Although we con­tend that the longer-term real re­turns for cash will be poor [in­ter­est rates are l ikely to re­main lower for longer], we view it as an un­der­rated source of tail-risk pro­tec­tion that will pro­vide us with the f lex­i­bil­ity to re­spond in a mar­ket cor­rec­tion.”

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