ETFs can protect your money from a bad economy

2015-03-02 15:29

To the uninformed observer, the apparent disconnect that currently exists between the South African equity market and the continuing poor fundamentals of the local economy can be mystifying.

Intuitively, a stock market should act as some kind of “barometer” of longer-term economic growth. In other words, if an economy is underperforming and is likely to continue underperforming for the foreseeable future, then surely this should be reflected in a weak equity market.

If South Africa was an isolated country and didn’t have strong international trading and financial relationships, that relationship would hold true, but this isn’t the case. South Africa is a small, open economy, with historically strong and deep international relations. In addition, the JSE All Share Index’s market capitalisation is heavily skewed in favour of large global stocks such as SABMiller, BAT, BHP Billiton, Richemont, Naspers, Anglo American, Glencore and others that derive the bulk of their earnings from outside South Africa.

Finally, the weak rand has played a pivotal role in insulating equity market investors from the ravages of inflation. The weakening of the rand currency has worked in favour of these companies, which largely earn profits in US dollars. So, the factors that drive the market capitalisation of the JSE All Share Index are not necessarily the same as those that drive the local economy. And for that, you can be truly grateful.

In the past 15 years or so, the JSE All Share Index has easily outperformed inflation, even when the index is converted into US dollars. This is in stark contrast to the S&P 500 index in the United States, which only recently broke through its 1999 peak and the FTSE 100 index in London, which has still to achieve this feat.

So local equity market investors can derive many of the benefits of having an offshore portfolio, just by being invested in the JSE All Share Index because the index is heavily weighted with foreign-listed stocks and other large stocks that derive the bulk of their earnings offshore.

One local factor that could influence the direction of the JSE All Share Index is, of course, the currency. In turn, the currency is affected by overseas perceptions of the health of the local economy. Ironically, you could reasonably argue that a poor economic outlook, which results in a sustained weakening of the rand, will result in a further strengthening of the equity market.

In this context, to refer to the performance of the South African economy in the past three years as “poor” is an understatement. Certain economic commentators have applied other less flattering epithets such as “slow burn” and “flatlining” recently. And unfortunately, looking ahead from 2015 until the end of the decade, a variation on the same mediocre theme seems to be our most likely, if very depressing, outcome. The petrol price is set to increase in March, after many months of a downward trajectory that imparted a significant boost to consumer spending.

The recently announced budget saw taxes increase across the board by 1% with upper-income earners taking a greater hit. No relief is forecast with respect to Eskom’s rolling blackout programme, which is likely to be with us for the next five years at least. The local economy is only likely to have sufficient power supply when the combined output of the Medupi and Kusile power goes online in 2020-2021.

In the meantime, it looks like South Africans may well have to “byt vas” (hang tight) for a few more years, with growth hovering around the 1% level. This is nowhere near what any economy that purports to be a developing economy needs. And it certainly won’t do anything to alleviate the misery of the millions of unskilled jobseekers in the unemployment queue. On the contrary, economic growth levels of this order are likely to result in further widespread job losses as firms cut costs in a desperate attempt to remain profitable.

So the message is clear: the local economy is likely to underperform for the foreseeable future but all is far from lost. Investors can protect themselves from low economic growth, higher inflation and a weak rand by investing in a variety of products on the JSE. Exchange traded funds (ETFs) offer the simplest and cheapest way of getting a really good and diverse exposure to quality listed stocks, both here and offshore. More sophisticated investors can consider segregated portfolios, aided by financial advisers and portfolio managers. As one well-known commentator said recently “buy quality, get paid for holding it and never sell”. In other words, do your homework by only buying quality shares, receive large and growing dividends on those shares and never be frightened into selling, especially when all around looks bleak.

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» Chris Gilmour is an investment marketer and analyst at ABSA Stockbrokers.

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