JSE driven by large economies’ consumption appetites

Adriaan Pask, PSG Wealth CIO.

The consumption appetites of the large economies of the world are the single biggest driver of earnings on the local equity market. The reality is that global demand drives profits, and when the large economies are consuming, profits tend to appreciate.

“When the US sneezes the world catches a cold” is a saying we all know very well, says PSG Wealth CIO, Adriaan Pask. A prime example of this was the 2008 credit crisis in the US, which later resulted in the global financial crisis.

There is however a common belief that the local economy drives the success of the local equity market. But there are also other important factors to take into account to appropriately gauge or anticipate future returns from the local bourse.

Locally there are currently some strong headwinds for local earnings and profits present - the interest rate cycle has turned, the country’s largest trade partner, Europe, is struggling, twin deficits are of great concern, sustained disruptions in labour markets and a lack of political leadership.

“Looking further, many JSE listed corporates have operations abroad from which they derive significant earnings. These earnings support local equity share prices, but are not nearly as challenged by local economic and political risks.

“The Top 10 companies by market capitalisation constitute 60% of the total market capitalisation of the JSE. Furthermore, the Top 40 companies by market capitalisation constitute 85% of the total market capitalisation of the JSE.

“Further considering that more than 50% of the earnings of these Top 40 companies are generated abroad, one can start to appreciate that the local equity market is not as reliant on the strength of the local economy as it may seem,” Pask said.

British American Tobacco (BAT) is a good example. BAT is the holding company for the group of companies that manufacture, market and sell cigarettes and other tobacco products. It is the world’s second-largest tobacco company by sales (after Philip Morris International). BAT has a market-leading position in over 50 countries and operations in around 180 countries.

There is also SABMiller with its headquarters in London in the UK and is the world’s second-largest brewer measured by revenues (after Anheuser-Busch InBev). SABMiller has operations in 75 countries across Africa, Asia, Australasia, Europe, North America and South America and sells around 21 billion litres of lager around the globe every year.

Compagnie Financière Richemont SA is the second-largest luxury goods company in the world (after LVMH). Essentially, the earnings from Richemont’s operations in Europe, Asia Pacific, the Americas and Japan account for all of its earnings.

To gauge consumption demand, earnings, profits and broader share price movements one can look at the New Sales Orders Index (or similar) as an indicator of demand for products in an economy. In addition, the more often used Purchasing Manager’s Index (PMI) broadly gauges economic output.

“It is a common fallacy to accept that the struggling local economy equals a struggling local equity market. There is more to it,” Pask says.