Do the predicted JSE returns justify the risk?

One third of the way into 2007, and investors are facing a dilemma. The dilemma is not the fact that several market commentators are expecting "an imminent collapse", as there have been numerous commentators who have been expecting this market to collaps

Investors who heeded their advice and adopted a "more cautious than necessary" equity positioning have paid a high price.

The dilemma facing investors now is whether the predicted returns of the JSE justify the risk. Consensus is for the JSE to return in the region of 15% this year. With the JSE currently up 13% for the year, investors could be forgiven for thinking the reward does not justify the risk, particularly, if finally, those predicting a collapse were correct.

So given all the uncertainty, what can we say with a fair amount of certainty?

To start with, both bullish and bearish commentators are probably right. Markets go through periods of confidence and a lack thereof. Economies go through periods of strength and weakness. At the moment, our economy is flying: we are creating record numbers of jobs, we are experiencing the longest period of growth since World War II and confidence is at 25 year highs. In addition, China is overheating at 11.2% growth year on year and according to Fortune 500, "American companies are enjoying the most sumptuously profitable period in the 500's fifty three year history".

So it is really no wonder that our market was up 41% last year and looks like it wants to do the same again this year.

However, there will also be shocks to the system, often completely beyond our control, which lead to a change in sentiment towards emerging markets. China could cool their growth, putting pressure on commodity prices and the rand. There could even be military action around an oil producing nation such as Iran. The US housing market could spook investors as it continues to let off steam.

So there will be corrections and it will be bumpy. However, given the fact that global and South African equities are not priced in dangerous territory and that earnings should continue to come through strongly, corrections should be short lived, as was the case in June last year and February this year.

Also, good stock pickers can find great stocks trading at significant discounts to the commodity heavy JSE. This is not dangerous territory. Dangerous territory, where most investors got burned, was when small caps in 1998 and technology stocks in 2002 were trading on PE's of 60- 100! Massive prices with little or no earnings. Over the past ten years, equities on the JSE have returned 17% per annum, and over the past five years 23% per annum. The ten year numbers include both 1998 and 2002 and illustrate the benefits of holding equities long term. For those who tried to move in or out of the market during this period, the returns were probably not as rewarding.

Recently released figures indicate that foreign purchases of South African equities are less than half of what they were this time last year, which makes sense, as the opportunities are less. Do not expect the massive returns of the past few years. Expect a more pedestrian performance, expect a bumpy road and expect an environment where cash and bonds provide an increasingly competitive return. However, the current environment remains more conducive to equities.

In summary, nobody can tell you where markets are heading in the short term, so be careful of trying to time your entry/exit regarding equities based on emotions. As long as you are not buying exorbitantly priced assets (and equities do not at this stage fall into this category) over three to five years you should be fine. Do not avoid equities; just manage your consumption thereof based on your risk profile.

By Jeremy Gardiner, Director, Investec Asset Management