JSE sectors: cheap or expensive?

In the current global economic climate, solid growth is a rare phenomenon. And where growth exists, it tends to be more prevalent in emerging-market economies. “The accommodative monetary conditions in the developed world should result in G3 nations’

Although the South African economy has come under some pressure of late due to the global situation, it has still managed to produce positive GDP figures. “While this growth may be somewhat behind that of the higher-growth emerging economies such as the BRIC countries, it is in sharp contrast to many developed economies that are all struggling with either sub-par growth or even looming recession,” says Stewart.

“However, the performance of the domestic stock market, which recently made new highs, compares favourably with other emerging-market stock indices. The main driver behind the latest surge on the JSE has been the recent spate of strong results from both industrial and financial companies, with financials actually pleasantly surprising market participants,” he says.

“In stark contrast, resources have had a difficult time, as commodity prices have experienced a very volatile period. Some commodities are still struggling to regain lost ground from the sell-off experienced in mid-2011.”

According to Stewart, this bout of underperformance from the resources sector has led to these companies currently looking very attractively priced at one standard deviation below the long-term average based on normalised PE calculations.

“The normalised PE ratio is based on a rolling seven-year arithmetic average for earnings,” explains Stewart. “Currently this sector is only slightly more than the previous record low reached in mid-2008 during the global financial crisis.

“Looking at the resources sector relative to its financial and industrial counterparts, the story supporting good value seems all the more compelling as this sector is currently trading at record low relative levels,” says Stewart. “Although the PE ratio of the industrial sector might seem very expensive at current levels, the longer-term normalised PE ratios for the industrial sector suggests that, while somewhat above its longer-term average, it still has room to move to the upside.”

In summary it looks likely that the resources sector, which constitutes almost 50% of the FTSE/JSE All Share market cap, is the one you should currently own. “But then there is also a reason for this low relative PE,” says Stewart.

“The market is concerned about a Chinese hard landing and the negative impact on commodity prices. These current normalised valuations of the domestic JSE sectors might indicate that resources are waiting for a catalyst, possibly in the form of better global and emerging-market economic data, to ignite them once again and keep driving the JSE to yet more record levels in the coming months.

“If and when this happens, we can probably expect a very abrupt upward move into the resources sector by investment managers who are currently underweight resources shares relative to the All Share Index,” he says.