Correlation of Rand vs FTSE/JSE All Share: what to expect
Foreign investors play a significant role in influencing the direction of the local stock market. When foreigners are net buyers of local equities, they drive up the price of the FTSE/JSE All Share Index, and vice versa.
Foreign buying in the South African equity market is normally accompanied by rand strength: in 2008 the rand lost 28,5% against the US dollar amid foreign selling to the tune of R54,4 billion, and in 2009 the rand gained 28,7% while foreigners were net buyers to the tune of R72,2 billion. However, there are periods where the rand and the FTSE/JSE All Share Index are negatively correlated (i.e. the two move in opposite directions).
Plexus Asset Management recently analysed the rolling six-month correlation between the rand/US dollar exchange rate and the FTSE/JSE All Share Index. The results reflect that the correlation tends to move in a cyclical manner between +1 and -1 (see accompanying graph). When the graph is above the zero line it shows that the two are positively correlated (i.e moving in the same direction). When the graph is below the zero line the two are negatively correlated (i.e. moving in opposite directions).
The correlation is currently at an all-time high (going back 15 years) of above 0,98. Looking at the historical trend of the graph, conventional wisdom indicates that a turnaround should be expected in the coming months, i.e. a move into negative territory.
While the rand has remained very stable against the US dollar for the year up to 30 April 2010, it has declined by over 3% since the end of April. Furthermore, although the FTSE/JSE All Share Index declined by more than 11% from 15 April 2010 to 7 June 2010 (and is still down 6% from 15 April to date), foreigners have been net buyers of South African equities during April, May and for June to date. While it appears as if the stock market is trying to extend the bounce from the current short-term oversold level, one should perhaps not be surprised if the rand experiences a devaluation at the same time
(Click on image to enlarge)
