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Has this bull market run out of steam?

06 July 2007 Gareth Stokes

As we entered 2007 most stock market analysts predicted annual growth of around 15% for the domestic equity market. We are now halfway through the year, and the market has already notched 15% higher. Given the massive run in domestic equities over the las

We joined Jeremy Gardiner, Director of Investec Asset Management and Clyde Rossouw, Portfolio Manager of the Investec Opportunity Fund to try and answer the nagging question on everyone's mind: "Is this as far as the market will go?"

Expect a soft landing as the bull loses steam

It did not take long for our experts to set the tone for the meeting. Gardiner summarised the consensus view by saying that "the sweet-spot of the bull run is probably over for now."

Rossouw mentioned that he was noticing a definite 'bearish' undertone amongst market commentators. To place the current bull market rally in perspective, Rossouw introduced a graph of the South African investment landscape from 1964 to present. The graph demonstrated the close correlation between the economy, corporate profits and share prices. Performances in these categories shadow each other closely, and when one outruns the other, market forces quickly intervene to restore equilibrium. Today, "share prices are again running ahead of the long-run performance of the economy," said Rossouw.

Another concept which supports the notion of a market losing steam is that of value. Rossouw illustrated this by comparing growth and interest rates. Historically, a trough in the interest rate cycle coincides with high company valuations. South African equities are presently clinging to high valuations despite the economy having experienced such an interest rate trough last year.

Gardiner spent some time focussing on the concept of value in the market. Many analysts believe the JSE is overvalued at present and various charts verify that the most common measure of value, the price earnings ratio is well above its historic mean. However, investors should be wary of confusing the ridiculous company valuations that preceded the dotcom boom with those present in the market today. Solid earnings growth and future growth expectations might underpin today's high JSE valuations.

Strong economic foundation from which to attack challenges

Although the domestic equity market looks set for a soft landing, there is plenty to be grateful for. Gardiner is very positive about the economic platform that exists in South Africa today. "I think the bottom line is there is a lot going right particularly from a financial perspective," he said. This economic platform was built over a number of years through a disciplined fiscal approach from National Treasury led by the Minister of Finance, Trevor Manuel and supported by the South African Revenue Services under Pravin Gordhan.

While problems such as poverty, AIDS and crime remain, Gardiner believes "We are tackling those challenges from a strong economic platform, and that makes a huge difference. If we were trying to tackle our challenges from a weak economic platform it would be much harder."

He expressed dismay at the 'disconnect' between what asset prices have done in recent years and local sentiment. Negative sentiment has resulted in many investors being less exposed to equities than they should have been. Gardiner stressed that these investors have unfortunately fallen prey to the highest risk in the market by simply not being invested heavily enough in equity over the last four years.

Gardiner also believes we should see reasonable returns as the bull market enters a slow-down phase. "Barring an abnormal event there is no reason why you shouldn't get another two to three years of solid inflation beating returns out of this market," he said.

No place for emotion in the investor's toolkit

In this market, it is essential for investors to discard emotion and select shares using tried and tested investment strategies. According to Rossouw, if he can find companies where the historic and forward price earnings multiples are at or below a certain price earnings ration, and he is convinced the earnings performance and cash flows of those businesses are sound, then he has a good investment case. Rossouw believes this price earnings ratio is currently at around 13.3 times, and the good news is there are still such companies out there "We can still find opportunities and put them into the portfolio to ensure reasonable returns, without taking unnecessary risks," said Rossouw.

Shares which met the above criteria would be bolstered by the following positive news. There is no sign of the commodity bull market coming to an end as yet. There will still be troughs and corrections along the way, but at least commodity prices will underpin the high valuations in a sector of the market going forward.

Editor's thoughts:
Investec's Opportunity Fund has outperformed equities and bonds over the last ten years, providing an annualised return of 24.82% since 31 May 1997. Mention this achievement to a local investor and you might be puzzled by his lack of enthusiasm. The truth is that local investors have been desensitised by the fantastic returns earned by any number of unit trust funds in the wake of the massive surge in equity prices since 2002. Are South African investors psychologically prepared for the lower equity growth the next two to three years will bring? Send your comments to


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