finweek

Why the JSE might be back in favour soon

Simon Brown, founder and director of JustOneLap.com.
Simon Brown, founder and director of JustOneLap.com.

I was never particularly good at ball sports as a kid. 

Some running and swimming was all I could do without making a total fool of myself. 

But my school insisted we try the various ball sports, and the coaches would tell us not to go to where the ball is, but rather to run to where the ball is going to be. 

It never made sense and I was always rushing to where it was and, of course, finding the ball was no longer there when I arrived. 

So, my entire ball sports career was pretty much me running after the ball but never making contact.

Markets are the same. We are always running to where the action is, trying to catch falling knives or buying the high flyers. 

The former hardly ever works and, sure, if you are early enough with the high flyers there is money to be made. 

But, as a rule, you should be looking where there is no action yet, getting in ahead of the action – going to where the action is going to be.

The reason is that if you get in on the price action early there is a lot more profit, whereas if you are only arriving halfway through (or worse, at the tail end) you will be left with just the scraps or the selloff.

With this in mind, 2017 saw the US markets flying and everybody was rushing offshore buying the FAANG stocks (Facebook, Apple, Amazon, Netflix and Alphabet’s Google) or even just one of the S&P 500 or Nasdaq exchange-traded funds (ETFs). 

The returns started out great, but the recent selloff has taken the steam out of the profits. 

So, what about the next couple of years?Returns out of the US markets will likely be modest for the next three to five years as the indices revert back to the mean. 

In other words, if the average return expected from US indices is, say, 8% and they have delivered 15% over the last few years, then the next few years will generate returns below the average in order for longer-term returns to revert back to the average.

Locally, our markets have seen pretty much zero return for the last five years. 

So here, if you take an expected longer-term average return for our market of, say, 12% (including dividends) then you have a lot of catching up to do in order for the average to revert back to the norm.

Buying the US now is going to where the ball is. 

The action has been in these markets, but over the next five years the action and returns are more likely to be in our local market (where the ball is going to be) as the local indices outperform the average in order to revert back to the average.

The question, of course, is what triggers the move higher (for local markets) and the lower return for US markets? 

The answer is most likely valuations. 

A strong storming market as the US has experienced, has been pushing valuations higher. 

Locally, the zero-return over the last five or so years has occurred while companies have been increasing profits. 

Sure, the increases have been very modest, but it still means our local valuations are attractive, giving us space for valuations to firstly revert to normal and then to expensive – thus offering the outperformance over the next three to five years.

A last important point is that we still need to be careful. 

For example, construction has been in decline for a decade and it does not look like it will end any time soon. 

We need to recognise these beaten sectors and just stay away, focusing on resilient sectors that have continued to make profits. 

This article originally appeared in the 20 December edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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