JSE rally has to come to an end, and it may be soon

JUST how long will it be before the JSE starts to reflect the weakness of the overall global economy, or the situation of resource stocks that still have the biggest weighting on the bourse?

Earnings aren’t nearly as supportive as they were last year or the year before. It should be worrying investors, or at the very least be a topic for dinner table discussion.

Yesterday, the all share index reached yet another record high. Driving the bourse to these dizzy heights is the hope of another round of quantitative easing by the US Federal Reserve as well as the statements made last week by the European Central Bank (ECB) governor that the Frankfurt-based bank would act to support the 13year-old euro currency.

Markets are hoping this Thursday’s ECB meeting will see the bank announce purchases of Spanish and Italian government bonds again, helping to ease the pressure on borrowing costs.

They aren’t being driven by fundamentals, but the promise of even cheaper money, I maintain, will come back to bite us in the long run in the form of inflation.

But just how high and how long can markets continue on this momentum? I guess it is becoming more a question of the appetite of foreign investors, who have been buying into our industrial shares. No doubt spurred on by emerging market gurus such as Mark Mobius, foreigners have piled into both our equity and bond markets.

Inasmuch as it is a search for growth, investors are paying for safety with stocks that have predictable earnings being bid up, while the cyclical stocks such as our resources are being sold off.

A closer look at the local bourse illustrates this. Mid-to-small caps have done really well this year, up in the high teens, while mid-cap property stocks are up close to 35% and industrials up in the twenties.

The top 40 index, the large caps, are up only 6,8%, being held back by resource counters.

Financial stocks are trading on very high price:earnings ratios, and many industrials on historic ratios of 20 and above. Out-of-favour resources stocks are mostly trading on single digit ratios.

Looking at those figures alone, there is the risk that the rally we are seeing on the JSE should surely come to an abrupt end soon.

It’s just a matter of time before foreign investors feel secure once more over investments in their home markets.

WITH a growing consensus that the common monetary union is heading towards a double-dip recession, the European Central Bank’s Mario Draghi’s announcement last week came at the right time.

Data from the European Commission’s economic sentiment indicator continued on its steep downtrend this month. Manufacturing and services reached new post-Lehman lows, with all declines beating expectations.

In such an environment, with Spanish bond yields soaring to lev- els that saw the governments of countries such as Portugal and Ireland calling for a bail-out, the ECB had to step up to the plate.

Markets have latched on to the statement, and expectations of another round of stimulus from the US, to rally. It’s an all too familiar scenario. You have to wonder what German Chancellor Angela Merkel really thinks about Mr Draghi’s and the ECB’s recent moves to ease fears. Markets are now expecting the ECB to announce purchases of Spanish and Italian government bonds again to help ease the pressure on borrowing costs both countries are facing.

The International Monetary Fund, the ECB, the European Union and Germany have applied much pressure on mainly southern European governments to reduce budget deficits and embark upon massive restructuring.

Market pressure on bond yields, and stock markets, have aided them. Germany, the region’s biggest economy and world’s fourth-biggest, has used the rising cost of servicing debt as a tool to increase pressure on nations to reform. Mr Draghi’s comments last week eased that pressure in the short term, and if the US Federal Reserve boosts liquidity in the system, the pressure to reform will more than likely fade away in the short-to-medium term.

Leaders of some of the more troubled economies could have a comfortable summer holiday.

It’s something that I can’t see Germany, in particular, to be too happy about.

The Bundesbank and some German politicians reportedly claim that a forceful intervention in sovereign bond markets would be a violation of the central bank’s mandate.

E-mail: derbyr@bdfm.co.za Twitter: @ronderby