HOW TO TELL IF THE JSE IS OVERVALUED
Are share prices on the local bourse on the verge of bursting?
this past Easter Weekend, we were privileged enough to enjoy a Sunday lunch with my parents at their retirement village. The dining hall was packed and we had barely arrived before the first course made its appearance. Shortly after, we were presented with the second course and then our main course moments after the previous one. I initially found this speedy service very strange, but it started to make sense later that day. We can easily fool our stomachs into eating more by feeding it fast enough, as there is a slight delay before we realise that it is full. Teary-eyed, I managed to finish my main course and while I was still trying to swallow that last bite, I heard the waitress say: “And for dessert...” I convinced myself that there was still enough room for desert and finished it, only to end up moaning and groaning in discomfort later that afternoon, convinced that my stomach was on the verge of bursting.
About five to seven years ago, investors worldwide were invited to invest, following what could be labelled as the worst recession of all time. Obviously they were cautious and artificially low interest rates were used as an incentive, much like the sherry served prior to the meal at the retirement village. Slowly but surely investors’ appetites for shares started to grow year-on-year. But with weak to negative growth in share prices, and volatility that has made its return to the market this past year, the big question is whether share prices are still overfed, or more specifically, overvalued. How likely are they to burst?
When we take a look at the historic priceto-earnings ratio (P/E) on the FTSE/JSE All Share Index, 21.5 times, and take into consideration that the year-on-year growth on earnings on these shares amounted to -14.5%, it certainly appears so. The average returns on equity of the Top 20 largest shares on the exchange are still around 17%, but when we place this in context by also mentioning that the average for the last five years was around 19.3%, it definitely tells us that caution must be exercised when tackling this meal.
Those who still doubt whether the market truly is overvalued may find the following indicators quite useful: 1. FTSE/JSE All Share Index Market Capitalisation/SA GDP ratio Although this indicator is used more successfully on US markets, it remains one of Warren Buffett’s favourite indicators. This ratio doesn’t only show us that we are currently trading at even higher levels than before the great correction of 2008, but also approximately 62% higher than the last 15-year average. 2. Equity earnings yields versus bond yields This indicator reflects the relative valuation of our local stock market versus the bond market. Bond rates have traded approximately 2.5 percentage points higher than the FTSE/ JSE All Share Index’s earnings yield over the past 15 years. At nearly 4.5 percentage points higher, based on this ratio, we can see that local shares definitely appear to be overfed at current levels. 3. Expected P/E relative to long-term average As I mentioned earlier, historical P/Es are definitely not trading cheaply anymore. Investors who wonder how the analysts’ expectations in terms of growth in earnings will affect this ratio will find that the situation remains quite dim. When we take a look at INET BFA consensus expectations, we’ll find that if this panel of analysts is correct, that the P/E (suggesting that prices remain at current levels) should fall to levels of around 19.5 times over the next 12 months. This is still 31% higher than the average P/E of 14.98 times over the last 15 years. Please remember, though, that these findings are based on historical data and it bears absolutely no promise for future movements.
All I do know is that this market appears to be overfed according to several indicators, so if you want to save yourself the discomfort that follows overeating, take proper measures to ensure that you are safeguarded against any overweight positions in shares.