LEILA FOURIE: How do we get back to rational investing?
The return of rationality in the markets depends on real and effective action by business, government and central banks
Five years ago, my PhD thesis on financial contagion warned of the potential dislocating effect of a contagious event in China. Though I extended the Black Plague metaphor to financial markets, I never expected I would have to navigate SA’s stock exchange through the effects of a coronavirus pandemic.
In March, the JSE had two of its five largest one-day drops in the all share index (Alsi), and the single-largest one-day gain. By the end of March, the Alsi was down 22% and major banks had shed 48% in market capitalisation in the year to date. The volatility reflected uncertainty in the global economy, and our local market bore the brunt of a rush for perceived safe-haven assets.
Financial history is a tale of opposites. Booms follow busts; peaks come after troughs. Recessions give rise to innovation.
The Great Depression began in the US in 1929 after the stock market crash of Black Tuesday. Between 1929 and 1932 the global economy experienced a 15% decline in GDP, a 50% decline in international trade and a 23% rise in US unemployment. By 1937, just when its economy was showing signs of recovery, the US faced another recession. The ensuing years would see alternating cycles of boom and bust.
The history lesson is borne out by the resilience of the JSE in its 133-year existence. Markets exist in a constant cycle of peaks and troughs of varying orders of magnitude. Asset prices periodically rally (and crash), investors switch from debt to equities, and innovation produces new investment products.
The stock market is often a bellwether for the underlying real economy. In 2019, the struggling economy and negative sentiment played out on the exchange. Foreign investors ended the year with net outflows in equities of R114bn — more than double the previous year. Conversely, net bond market outflows of R22bn were a fraction of the R108bn in net outflows in 2018.
Conditions change and the balance of performance reverses itself, but markets are ultimately driven either by rational behaviour, or by panic and fear.
Now the world faces an unprecedented health crisis. There is neither a cure for this disease, nor real understanding of its life span. There are too few constants and too many variables.
But while this uncertainty will play out on the JSE, the exchange and banks are deep and liquid. The JSE’s uniquely high market capitalisation to GDP of greater than 350% demonstrates the depth and sophistication of our local capital markets relative to our real economy.
Our exchange offers diverse asset classes that tend to counterbalance over a cycle, trading on world-class dual-listed companies, and sought-after rand hedges. Our local asset/fund managers provide a vital underpinning to our markets, filling the vacuum of liquidity left by international investors who inevitably exit during a downturn.
What will happen after Covid-19? History shows that the number of listings in mid-cap companies contracts during a downturn. Many businesses that survive the first wave of lockdown may need emergency funding, translating into a demand for alternative capital raising.
As demand grows, the market will adapt to provide solutions for sustainability bonds, SMEs and infrastructure projects. The JSE is actively contemplating private placement solutions for these markets.
The volatility of the crisis may give way to innovation and change the way we think about investments.
Consider a scenario in which an economic downturn reaches further than initially anticipated: we could witness continued pressure on the rand exchange rate and steep increases in the yields of SA government bonds. SA may find itself offering a relatively attractive yield, despite junk status and the significant reduction in interest rates.
With much of the developed world facing interest rates of close to zero, investors may start re-evaluating the way they perceive junk ratings.
One of the strengths of SA’s fiscal profile has been the National Treasury’s astute management and diversification of the maturity spectrum of its bond profile, which builds investor confidence.
On the commodities front, good weather has improved the outlook in this market — albeit tempered by potential supply chain complications.
In the aftermath of structural economic and policy reform, the public and private sectors need to partner to ensure long-term, inclusive and sustainable growth if we are to sustain the cyclical nature of our markets.
With little certainty in the short term, we can look to the rhythm of the markets in the long term.
The ultimate stabilising of the economy — and, by implication, the financial markets — will depend on real and effective action by business, government and central banks. This will lead a return to rational investing.
- Fourie is CEO of the JSE