Sniffing out value on the JSE
Most financial planners will advise you to stay invested for as long as possible to maximise equity returns. They argue that over a period of 30-years, for example, you will avoid the wild market volatility that so often decimates short-term returns. It’s
In his presentation, Time and the Market, Alwyn van der Merwe, director of investments at Sanlam Private Investments (SPI) offered his take on the “time in” versus “timing” debate. He was clear from the outset that a fund manager would be remiss in his duty if he didn’t act on a clearly held view on short-term market trends. Nobody wants to remain invested blindly in an index tracker when the best returns stem from being correctly allocated to asset classes and sectors within those asset classes. You don’t want your entire portfolio to be dragged down by one underperforming sector. If the indicators suggest dismal prospects in resources in the near term you want to diversify into other sectors with more promise!
Underpinning the investment decision
Although economists’ predictions are often way off the mark, fund managers have to develop macro economic forecasts to place their investment decisions in context. They need to have an idea of the overriding trends in domestic interest rates, growth rates and CPI to position their clients correctly. And they have to make a call on market sentiment using valuation tools (such as price-to-earnings (PE) ratios) and assessments of future demand for equities (by considering investors’ cash-to-equity ratios).
The PE ratio is a commonly applied value indicator. If share prices increase without an equivalent improvement in earnings, the PE ratio climbs. That’s the situation we’ve experienced since March 2009! The jump in the local PE ratio is due entirely to a market re-rating – meaning that if earnings don’t follow the market is over-priced at current levels. “I don’t think company earnings will be ‘pretty’ in the next three to four months,” warns Van der Merwe. The latest forecasts point to a 23% decline in 2009 earnings, followed by a sharp recovery in 2010 and 2011.
Unpacking the recovery
How will the recovery play out over time? SPI’s model documents four stages, labelled contrarian, momentum, overheating and bubble. During the contrarian stage equity prices are driven by a single leading indicator. Value investors climb in like there’s no tomorrow. The second phase is characterised by significant improvements in macro and micro-economic indicators. Momentum investors get back into the game as they hope to ride the wave of euphoria to higher prices. They remain invested in the third stage – overheating. Companies and analysts tend to overstate earnings expectations in this stage – leading to the market surging higher than it should. In the final stage, optimistic expectations for ROE and earning growth flatten the market, creating opportunities for all investors.
Timing your “buy” and “sell” calls is not that easy
SPI used a ‘real life’ example to demonstrate the market timing debate in action. In July 2008 the group believed Standard Bank was a buy. At the time the counter was changing hands at just R75/share. When discussing this view with one of the group’s larger clients they ran into some unexpected resistance. This individual was adamant they’d be able to purchase the share at R60 in the near future. What did SPI do?
Van der Merwe says they went ahead and bought Standard Bank at R75, despite the possibility it would fall further. There were two main reasons for the decision. First – market sentiment is very difficult to judge. A fund manager must base his decisions on the fund mandate and the information available at a given point in time. It would be unprofessional to allow a single client – even if that client were institutional – to overrule. Second – the value argument for an investment in Standard Bank was compelling at the time. SPI knew they would make money from the transaction in the long-term. With hindsight we know Standard Bank plummeted to R60/share in September 2008… Just because a share trades at a certain level doesn’t mean an institutional investors can get their hands on the stock. Van der Merwe doubts that any large market players would have picked up significant lines of stock at those levels. Today the counter is trading at R97/share and SPI has locked in a respectable 29% capital return!
And you can still motivate a purchase of Standard Bank at R100/share. All you have to do is consider the I-Net consensus forecast for dividends per share in 2012 (three years from now). SPI says given the 603c/share dividend forecast the counter should change hands at R172/share by then. So a purchase of Standard Bank at R100/share today should provide an annualised 19.8% capital return per annum! Add back the 3.5% dividend and you’re sitting pretty with 23.3% per annum. Against the backdrop of recession there are few investors who wouldn’t snap up such a deal!
Editor’s thoughts: There you have it. Time in the market remains a top strategy – but not at any cost. If you have good reason to ‘lighten’ your equity exposure you should act accordingly. The alternative is to suffer unnecessary reductions – albeit small – in your long-term return. Have you ever made an investment mistake in an effort to time the market? Add your comments below, or send them to gareth@fanews.co.za
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