Making sense of a JSE moving sideways
The JSE has largely moved sideways in recent times. What are the conditions that will put it back on an upward trajectory?
The recent performance of the JSE will have disappointed many South African shareholders. Since 1995, the JSE All Share index has had its downs, but long-term shareholders have been more than compensated for those. Over the same period, average annual returns, calculated monthly, have been 12.9% compared with average headline inflation of 6.2%.
In contrast, between January 2016 and May 2017, the share market moved little in either direction. The worst month in this period was February 2016, with negative annual returns of 4.4%, and the best was the close to 10% in January this year.
A different picture is presented when the JSE All Share index is converted into US dollars: the index (excluding dividends) is up 24% since January 2016, a gain that compares reasonably well with that of the emerging-market benchmark, the MSCI EM index, which is up 28%, and the 19% achieved by the S&P 500.
In dollars, the JSE has over the past two years sustained its close correlation with the EM index, recovering the ground lost against the S&P 500 between 2011 and mid-2016. However, they have realised more in dollars than in local currencies, including the rand, which has strengthened materially against the dollar since mid-2016. In rand, the JSE has gained 3% in 2017 (up to June 8) and the EM index is up 10%, while the S&P 500, at record levels in dollars, has gained a mere 2%.
By early June, the rand had gained 6.3% against the dollar this year and was 20% stronger than its worst levels seen in January 2016. The rand also gained ground against most emerging-market currencies. It blew out against its emerging-market peers in December 2015 when Nhlanhla Nene was removed from the position of finance minister, but recovered consistently after mid-2016 and is almost back to its 2012 level.
The removal of Pravin Gordhan as finance minister in March this year had little effect on the rand/dollar exchange rate and on the value of the rand compared with a basket of 11 other emerging-market currencies (which have also gained against the dollar). Moreover, the spread between the yields offered in dollars by the South African government, compared to the yield offered by the US Treasury, is now no higher than it was before December 2015.
The interventions made by President Jacob Zuma have clearly influenced the rating agencies. They have downgraded South African debt. Yet the market, it seems, has largely got over the threat, concluding – rightly or wrongly – that the threat to South Africa’s ability to service its debts has declined. Time will tell.
Rand strength on its own is not directly helpful to many stocks listed on the JSE. These are the global companies whose major sources of profits are outside the country. A combination of rand strength, especially for South Africa-specific reasons, is unhelpful to their rand values. A given dollar value for their shares, largely established by the global investor, will then translate into lower rand values. So when the rand gains 20% against the dollar, it would take annual appreciation of more than 20% in the dollar value of a stock to translate into an increase in the rand value of a dual-listed company – a demanding rate of return.
This is a rate of return that few, apart from Naspers, have met. Indeed, some of the important global plays listed on the JSE have suffered from weaknesses specific to their own operations, which have dragged back the JSE All Share index.
While rand strength is a headwind for many, it can be a tailwind for firms that depend on the fortunes of the South African economy. To help them, the strong rand and the lower inflation that follows need to be accompanied by lower interest rates. Lower interest rates stimulate household spending and borrowing, which then helps the earnings of retailers and banks. This move in interest rates has been delayed by the South African Reserve Bank, despite the recessionary forces that higher interest rates since January 2014 have helped produce.
This is revealed in the trailing earnings of the Financial and Industrial index (Findi) that are not yet back at 2015 levels – though they are now growing. In dollars, Findi earnings per share are yet to recover to 2011 levels.
These reported earnings moreover do not suggest the Findi is undervalued, given current interest rates. A regression model of the Findi suggests the index is now about 20% overvalued and has remained so since 2013, despite the stagnant level of the market.
The market has implicitly remained optimistic about a recovery of earnings, which is now under way but took a long time to materialise, given higher interest rates. Lower interest rates would be essential to justify current market levels.
A stronger global economy will help improve the dollar value of the JSE-listed global plays and, depending on the exchange rate, perhaps also their rand values. A weaker rand may help the rand values of the offshore-dependent part of the JSE. But rand weakness might (wrongly) delay lower interest rates. The best hope for the JSE is a strong global economy, combined with a strong rand and a recession-sensitive Reserve Bank.
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Prof Brian Kantor is chief economist and strategist at Investec Wealth & Investment.
This article was paid for by Investec.