Warnings of JSE meltdown

2014-01-23 00:00

A CAPE Town-based investment analyst warns that the Johannesburg stock market has all the ingredients of a bubble just prior to a financial meltdown.

Fortunately, not all investment analysts share his view.

Craig advises caution and recommends that investors safeguard their capital.

“Each time the Alsi PE (price to earnings ratio) reached this level, there has been a material correction or crash … post the 1969 bubble,” Craig said in a recent note.

“Our investment careers do not go back as far as 1969, but we were investors through the Alsi PE peaks in the 1990s. All … the peaks had one thing in common — investors ignored the warning signs that SA equities were expensive and thought the good times would continue. They did not!” he said.

However, Vestact analyst Michael Treherne said they did not believe local shares were “over-valued,” but instead were “fairly-valued”, based on forward price:earnings ratios.

“A lot of guys say the market is over-valued because they need to justify why they were not in the market during last year’s bull run,” said Treherne.

He said most big companies on the JSE now derived a large proportion of their income offshore, and so their earnings were benefiting from rand depreciation.

Absa Capital Markets analyst Chris Gilmour said there is not doubt that the market is expensive — current price:earnings ratio’s are an average 18,19, but the long-term average is 14,5.

Gilmour said however he expects the market to continue rising “inexorably” this year, driven by its own momentum — fixed interest rate instrument returns are low at around four percent so that money has to find a place somewhere — and in spite of the disconnect between economic performance and earnings growth, and the rise in market prices.

“I don’t see a bubble. If we get three percent growth in the economy this year, it will make our market look a little better … the alternative is to ghastly to contemplate,” Gilmour said.

Gilmour said in previous periods when the JSE was over-valued, interest rates had risen, causing investment flows to flow into fixed interest type investments.

This was not the case currently.

Craig said South African equities seemed expensive and last year’s gains were supported by multiple PE expansion, rather than strong fundamental earnings and cash flow. This is hardly a good formula for great investment returns.

There are currently signs in South Africa that are similar to the pre-1998 global financial crisis, he said.

In 1998, according to Craig, emerging market currencies came under unyielding burden following a global contamination caused by the failing of the Thai baht.

“The recent depreciation of the Turkish lira as a result of unrest, corruption, cabinet minister firings etc. gives us much cause for concern and the rand has started 2014 with a weakening bias,” said Craig.

Before the 1998 global crisis, capital quickly moved from emerging markets back to developed markets. “We have seen the beginning of this trend again in 2013,” he said.

According to Craig, last year was the third year in a row where foreign investors were net sellers of South African equities market.

“Even if inflows do return to emerging market equities in 2014, South Africa’s high relative valuation should limit potential inflows,” Craig said.

Gilmour said there was a belief among some that the weak rand would boost exports and spur economic growth, as happened in the past, but “we’ve become less and less relevant on the world stage for our manufactured goods.”

Terence Craig of Element Investment Management is concerned that last year’s 21,4% surge in the JSE’s All Share index is worryingly similar to the 1998 equities upsurge that occurred just before the global financial meltdown.

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