Equity investors stuck with a spot of indigestion

Gareth Stokes, FAnews Online Editor

Since October 2009 the JSE All Share index has settled into a sideways trend. Instead of watching your equity portfolio power ahead, you’ve had to satisfy yourself with a 0.8% return from this asset class in the first 75 days of 2010. Alwyn van der Merwe, director at Sanlam Private Investments (SPI), equated this lull in share prices to a serious case of indigestion. Investors and fund managers who gorged on ‘cheap’ shares through the market turnaround must now deal with an “uncomfortable burning sensation.”

The lacklustre equity performance is accompanied by a big jump in volatility which links to concerns about market valuations and the sustainability of the global economic recovery. Analysts who ploughed into equities have begun wondering whether there’s enough good news to back their decisions. Equities cannot move higher until clear signals on earnings and domestic growth emerge. There are also renewed concerns the global economy overshot fundamental measures. The world exited recession at breakneck speed despite a raft of systemic issues. Try as they might analysts and economists cannot shake the fear of a ‘double dip’ market correction.

Fear of a ‘double dip’ remains

If the ‘double dip’ pattern plays out equity investors can expect a sharp decline in global markets as early as the first half of 2010. Van der Merwe identified five factors fuelling this possibility. The first is the threat created by sovereign debt. Developed economies ran into recession with massive debt and had to spend billions more to prop up their faltering financial systems.

Economists are no longer talking about drivers of economic growth but rather countries on the brink of collapse. The BRICs (Brazil, Russia, India and China) – once the centre of attention – have been temporarily replaced by the PIIGS (Portugal, Italy, Ireland, Greece and Spain). Greece is in serious trouble right now. The country owes $270bn to banks predominantly in the European Union. It owes France ($86bn), Switzerland ($60bn) and Germany ($44bn) – and owes the US a whack of cash too. If Greece plays bankrupt the fallout will echo through the financial world and trigger an immediate market correction. And South Africa won’t be spared.

The second fear relates to the quantitative easing applied during and immediately after the financial crisis. Governments cannot afford to prop up economies indefinitely and it remains to be seen whether some of the more fragile economies can stand on their own feet. China is the third ‘weak link’. Economists are worried the emerging market superpower will run out of steam as it struggles to carry the whole world on its shoulders. Much of the post-recession economic growth is thanks to the Chinese keeping their engine firing on all cylinders. If they take their feet off the accelerator the engine will backfire with unpleasant consequences. Threats number four and five come from the United States and include the burden of increased bank regulation and concerns over US employment momentum.

Wearing two hats

The result, said Van der Merwe, is asset managers who are positioned as equity market bulls no longer know how to respond to negative news. He coins the term “bearish bulls” to refer to an audience perched on the edge of their seats and ready to leave the auditorium at the first sign of trouble. SPI has a more mature approach. “We don’t think any of the above risks will be ‘game changers’ over the next 12 to 18 months,” says Van der Merwe. He says SPI will take advantage of any dips to increase its equity holdings.

Equity returns will be guided by earnings through 2010. More than 65% of S&P 500 firms exceeded analysts’ earnings expectations, with 55% beating revenue forecasts. If local companies follow their US-listed peers the outlook is quite good. At the end of February 2010 local analysts expect 40% earnings growth across the All Share index and a massive 82% from resources companies. “It’s quite possible we’ll see 82% earnings growth from resources shares provided commodity prices remain firm,” said Van der Merwe. Impala Platinum earned 2168c/share in 2008 and a paltry 336c/share in 2009. Even a disappointing number by 2008 standards will result in fantastic 2010 earnings growth.

Economic uncertainty and tough valuations make markets ‘no go’ territory for DIY investors. It makes sense to leave share picking to the experts. They understand the risks to individual sectors and appreciate the impact FY2010 corporate earnings will have on overall market returns.

Editor’s thoughts: South Africa’s All Share index is dominated by resources shares. Earnings at these companies plummeted through 2009 on the back of soft commodity prices and lower demand. Industry stalwarts such as Anglo American (-35%), Impala Platinum (-85%) and ArcelorMittal (-105%) watched earnings evaporate last year. Do you think resources shares will be able to boost 2010 earnings by 82%? Add your comments below, or send them to gareth@fanews.co.za