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Let the good times roll

18 October 2007 Gareth Stokes

Jeremy Gardiner, director of Investec Asset Management shared some of the group's global market views with the Media on Wednesday, 16 October 2007. The message to emerge from the presentation was: "Don't avoid equities although the equity outlook is bumpy, from a pricing perspective they remain reasonably priced and exposure should be based on each particular investor's risk profile."

A quick look at equity returns on the JSE over the last ten years supports this view. Investors were rewarded with 18.8% per annum over this period. The five year return is even more impressive with 29.7% annually. And at the moment the JSE All Share Index looks set to easily eclipse the 15% target bandied by many analysts for 2007 full year equity returns.

Shares are bordering on expensive

Despite this positive sentiment, shares on the local exchange are starting to look expensive. The JSE All Share Index is trading at an average price-to-earnings ratio of 16 times. And the 1-year forward ratio (which reflects earnings expectations for the coming year) is already 13.2 times earnings. Both these measures are higher than the long-term average, which stands at 11 times. Are these numbers cause for concern?

Gardiner notes that the historic number includes business performance during the dark days of Apartheid. In other words, the historic average is probably much lower than it would have been if South African business was conducted in a normal environment. If these economic abnormalities had not existed, then the prevailing forward price-to-earnings ratio would not be unrealistic.

That said, both Gardiner and Investec's head of equities, Sam Houlie believe investors will need to moderate their equity return expectations. There is simply no way that earnings growth will continue at the pace we have observed in the last five years. The result will be that share price growth slows or market ratings become even more expensive, increasing general levels of market risk.

What shares are worth looking at in current marketing conditions? Houlie believes there are plenty of value opportunities in the banking sector. He mentioned Standard Bank (and some of the media pointed out, Investec too). Houlie also likes companies in the insurance sector, mentioning Liberty as an example. Diversified industrial heavyweight Remgro is also worth a look. And of course some exposure to resources remains sensible going forward.

Struggling to shake global market concerns

Global investors are waiting for the US economy to shake off its lending practices hangover. The fallout from the sub-prime crisis has driven 'housing starts' in the US to a 14-year low. It is interesting to note that the uneconomic lending practices largely contributed to the house price boom in the US since 2000.

The rest of the impetus came from investors dumping equities and ploughing their money into houses in the wake of the Dot-com stock market crash. US prosperity since 2000 has not been backed by genuine economic gain. Instead it was built on the back of borrowed money and house-price backed consumer spending. There is little doubt the US will struggle to shake its woes in coming years. While it may not enter a full-blow recession, there is certainly room for an economic slowdown.

Fortunately the US is not as big a global market player as was the case in the past. The International Monetary Fund expects global growth to remain resilient in the face of US concerns. It expects average GDP growth of 5.3% in 2007 to fall slightly to 4.9% in 2008.

South African resources in demand

South Africa can take heart from the fact they are perfectly positioned to benefit from this global economic growth. The country's abundant resource stockpile will is in demand from emerging economies like China and India. Each of these countries is hungry for African resources to fuel near 10% annual growth. And this resource demand should ensure the JSE posts its fifth consecutive year of positive gains.

A perfect illustration of the country's economic prosperity is found in comparing the situation in the 1980s with today. Back then our economic growth was less than 1% and the population growth stood at between 4% and 5%. Today the situation is totally reversed. This domestic economy strength has contributed to the sterling local equity performance over the last decade, and last five years in particular.

There is no serious threat of a market crash in the foreseeable future. But investors have to be more cautious and select their stocks carefully. The prevailing cry right now is "Hold equities; but temper expectations!".

Editor's thoughts:
It seems most investment analysts favour equities in the next two to three years. There seems enough evidence to support their view. However, recent increases in interest rates meant that returns from cash are significantly better than two years ago. We would be interested to know your views on cash as an investment right now. Should investors consider holding more assets in cash in the short term? Send your comments to
gareth@fanews.co.za

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