Between a rock and a hard place

With the JSE trading on a P/E of about 14.5 times, many astute investors are questioning the sustainability of the bull market globally and in South Africa.

According to Adrian Clayton, at Alphen Asset Management, this is particularly relevant in that early adopters have enjoyed returns of 100% and more since the P/E bounced off 8.5 times two years ago. Investors currently in my opinion face three dilemmas. The first being based on the question: 'Should gains be banked?'

Having just been through our quarterly strategy meeting, it is clear to me that investors and asset managers face very interesting times currently. I say this not because we are bearish on the market, but because one feels caught between a rock and a hard place.

On the one hand good asset managers have made lots of money for clients of late and the natural tendency is to secure profits, but against this, the market is still not onerously expensive and this is particularly applicable when compared to other asset classes.

Many highly rated stocks on the JSE are still likely to grow earnings as much as 20% over the following twelve months and these types of returns are certainly not foreseen in other asset classes. Added to this the JSE continues to enjoy a strong undertone, as do other global bourses.

South African investing feels similar to the problem occurring abroad, that is equities become a default asset class because they are simply 'less expensive than everything else'! This in itself is risky.

A second dilemma which is currently evident in South Africa is 'top of the cycle P/E's'. What I mean by this is that the market has a natural tendency to lure unsuspecting investors into what can be termed a value trap or top of the cycle P/E.

Common wisdom dictates that shares are cheap when P/E's are low, but this is not always true. Unfortunately, sometimes when earnings have simply been outstanding for companies and the market feels that this is likely to be unsustainable then share prices come to a grinding halt.

Buying these 'cheap' shares can lead to nasty surprises in that the P/E can escalate if the companies in question do not actually produce results. Thus cheap shares become horribly expensive without price gains. This is typical of commodity companies and it is often the best time to buy these stocks when the P/E's are very high.

We have fears that certain favoured sectors on the JSE could be value traps!

The final dilemma is the secular versus cyclical story. Secular implies consistency; it is usually accompanied by terms such as 'paradigm shift'.

My normal inclination when 'gurus' refer to secular trends or paradigm shifts is to quickly dig a fox hole as you can bet your bottom dollar that trouble beckons.

We heard about secular earnings of IT companies just before the bubble burst in March 2000, we now know that IT companies' earnings are more cyclical, implying volatility, than Aunt Gertrude whilst skipping her happy tablets.

Currently, analysts are referring to two secular themes, the one a global phenomenon, being a long-run commodity bull market. The other related to South Africa, that being a powerful demographic shift which is likely to buoy consumer spending and share prices forever amen.

My response to this is that while we are extremely positive on South Africa's future, all countries incur hiccups on their way to prosperity and we will be no exception.