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Equity analysis

21 May 2004 Angelo Coppola

Wild swings up and down are part and parcel of being invested in equities says Shaun le Roux, a fund manager at PSG Fund Management.

The most commonly used measure of risk for different financial assets is volatility, or deviation in returns.

Share portfolios have given investors the best returns over time, but this has been at the cost of vicious short-term movements driven by economic and interest rate cycles, currency movements and changes in market sentiment.

The past few weeks have been an excellent example of the swings that investors in shares experience from time to time.

In April of this year, almost exactly a year after the JSE commenced on a strong recovery path during which the All Share Index gained 55%, a sharp sell-off commenced with the bearish mood emanating from worries on Wall Street.

To date, the All Share has lost almost 12% in just less than a month, with specific sectors like resources and telecoms taking more severe knocks.

To understand what is causing jitters on stock markets worldwide one must recognise what drove the massive recovery in global equities from March 2003.

After the popping of the tech-induced bubble in 2000, global equity markets suffered a three-year slide. During this time recessionary economic conditions, poor profitability, corporate accounting scandals and the Iraq war took their toll, and the Dow Jones Index lost 36% of its value.

The recovery in economic conditions and stock prices was engineered by cheap money through low interest rates, tax cuts and a weaker US dollar, and the Dow Jones regained 42% in less than a year.

A new player, China, emerged as a key element of the recovery as the country's growth and demand for materials continued at a phenomenal rate.

Recent data from the US has provided compelling evidence that the country's economy is enjoying a normal and healthy recovery. This implies a pick up in inflationary pressures and the commencement of interest rate hikes is imminent.

This has spooked a previously sceptical capital market which had seemingly expected interest rates to stay practically zero for ever. Then, Chinese authorities announced measures to slow their economy down to prevent it from overheating.

All of a sudden two of the market's sources of fuel - low rates and the China factor- have been curtailed, hence the rush for the exits and the massive unwind of speculative positions in equities and commodities.

The way forward for global stock markets, and remember we cannot escape their influence on our bourse, will be determined by corporate earnings in the months and years to come.

At this point in time, US profits are growing strongly and are consistently beating expectations. Further dollar strength and stubbornly high oil prices do pose a risk to future earnings, but as things stand profits are forecast to continue to show healthy growth.

The future performance of the dollar is probably the key ingredient of the future global economic environment. We expect further weakness from the greenback.

We are of the opinion that South African shares offer good value at the moment. After recent losses, even resource shares are starting to offer value and our forecast price-to-earnings ratio for the JSE in twelve months is under 11, which is below historic norms.

Given a projected earnings growth rate of 20% over the next year we believe that investors can expect a decent return without any re-rating of the market. On an absolute basis, some local industrial and financial shares are looking very attractive at current prices.

The behaviour of the rand will continue to have a significant effect on the performance of the JSE.

The period of sustained strength over the past two years can be ascribed to three factors: an unwind of the 1990s rand panic, strong commodity prices and interest rates high enough to attract foreign capital. In the current environment, we expect commodity performance to be the main driver of the currency.

We don't believe that the bull market in commodities is over, hence we expect the rand to stay relatively strong, particularly if the dollar loses ground.

Having said that, with much of the speculative attraction receding we think it is unlikely that the currency will be making a new high against the dollar. A gradual decline in line with inflation differentials is likely to resume soon.

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There are countless articles written about South Africa’s poor retirement outcomes. Which of the following would you single out as the biggest contributor to local savers not accumulating enough to buy an adequate and sustainable pension?

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Poor participation in formal retirement funds
Reluctance to seek financial advice early on
SA’s high unemployment rate
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