The first quarter madness is behind us
The first quarter of 2008 has already flashed by. To find out what the first three months of 2008 delivered FAnews Online attended a presentation by Sanlam Private Investments’ economist Alywn van der Merwe. He shared some of Sanlam’s views on events sinc
By having a balanced long-term view of your investments you can relax through short-term market activity. You don’t need to suffer the daily stress of calculating how much your share portfolio has lost or gained in a single day. Instead you can evaluate your portfolio at more sensible intervals. Despite all the negative news and market turbulence the JSE All Share Index is actually up 1.02% for the quarter to March 2008.
Will equities deliver more ‘cream’ in 2008?
Investors have become accustomed to fantastic equity returns in the last few years. Van der Merwe produced a graph of the JSE All Share Index showing a 43% growth in 2005, 37% in 2006 and 16% in 2007. If you add 3% for dividend yields to these numbers you soon understand why the stock market remains the best asset class to invest in. A major driver for equity returns on the JSE has been the resources sector. By now you all know about the major moves in commodity prices – with gold ($1 030) and platinum ($2 273) posting all-time highs in the first quarter. This helped the local index of resource shares post 48% annualised returns over the last three years!
If we strip resource shares from the equation then the three year annualised returns drop from the spectacular to above average. Industrial shares managed 24% and financials 15% over the same period. Of greater concern is that both these sectors have entered a sideways or downward (in the case of financials) trend since April last year. This is part of the reason Van der Merwe warns we are unlikely to see a repeat of 2007 returns in 2008.
To understand why returns will be lower we need to consider the various elements that drive equity prices. Van der Merwe says these drivers include interest rates, growth rates, valuations and earnings growth. He then throws the outlook for the global economy and the potential for further commodity price growth into the mix. How will trends in each of these areas impact equity prices in 2008?
What do the trends reveal?
Let’s begin with a look at valuations and corporate earnings. Most analysts begin their investment decision with a view on weather the market offers value (is cheap) or not (expensive). The foundation for this assessment is usually the price earnings (PE) ratio. This ratio tells us how many years of future earnings are built into a particular share price. Going back almost 50-years the average PE for shares on the JSE is around 13 times. At the end of Q1 2008 shares are trading near 15 times, which is not cheap but certainly not in ‘bubble’ territory. The trouble with PE ratios is that they reflect historic figures.
To get a feel for where equities will go in the coming year we need to find out what future earnings are likely to be. The share price explosion that we’ve experienced since 2003 is on the back of spectacular real earning growth. In other words companies have been rewarding investors’ faith with stellar annual results. Van der Merwe believes it is unlikely companies will be able to maintain the nominal 27% per annum growth in earnings we’ve seen in the last few years. The consensus is that we’ll experience a moderation in future earnings in line with a slight pullback in GDP.
South Africa’s GDP is likely to shed a point or two in the wake of international economic concerns and the much talked about domestic power crisis. Most economists estimate the GDP will revise down from around 4.5% to 3.5% for the 2008 year. We believe this might prove a trifle optimistic; but time will tell. Even so, the combination of lower than expected GDP combined with the higher interest rate scenario are going to exact a toll on corporate earnings in the immediate future. And that’s part of the reason equities are going to struggle provide investors with the stellar growth that’s been available since 2003.
The best place to be invested
Van der Merwe notes that it’s difficult to identify the next big investment theme. He spent a great deal of time demonstrating why South Africa’s banking sector might outperform the resources sector in the coming year. But his analysis includes a number of ‘ifs’ and ‘maybes’. If the Chinese economy slows and demand for resources fall we could see big corrections in the prices of almost all commodities. Shares in the resources sector will suffer... Banks, on the other hand, have already fallen quite a way from recent highs. If the fallout from the global sub-crime crisis is resolved then investors are likely to pile into the banks which are all trading on low forward PEs of around 8 times.
For investors who prefer the slow and steady approach Van der Merwe identified some of the stalwarts in the Sanlam Private Investments equity portfolio. These include industrial rand hedges like Remgro, Bidvest and Steinhoff. Remgro is attractive because of possible corporate action around its stake in British America Tobacco. And Steinhoff makes a great rand-hedge due to it earning more than 50% of its revenues offshore. Other favourites include Murray & Roberts (the construction giant) and Standard Bank.
The market will probably return slightly less in 2008 than the 16% (plus 3% dividends) of last year. But careful stock selection should ensure you outperform the All Share Index.
Editors’ thoughts:
Despite global market concerns most analysts remain upbeat about prospects for South African equities. But local businesses face a number of challenges including rising interest rates and Eskom’s inability to supply sufficient electricity. Do you think analysts are allowing enough for the damage that the local power crisis will cause? Add your comments below, or send them to [email protected]
