Tilman Friedrich’s Benchmarks July / August 2014
The investor should in the first instance be wary of investing when the market is above the trend line as it currently evidently is. It is thus not the right time to increase one’s equity exposure to the local equity market now but to rather wait for the market to retract. A similar graph for the US S&P 500 also indicates that it is at first sight not the right time now to increase one’s exposure to US equities. A further consideration is whether the trend line is representative of a fair growth rate of companies represented by the index. The JSE Allshare Index trend line represents an annual real growth of roughly 4% per annum, while the trend line of the S&P 500 represents an annual real growth of around 3%. Assuming that the respective indices are not distorted by factors such as significant changes in the composition of the index, or a significant divergence between a small number of large companies and a large number of small companies, we would argue that in both cases the trend line fairly represents the growth that can be expected to be delivered by the companies measured by these indices. In the article in Moneyweb of 23 July, Patrick Cairns concludes that the local index represents a ‘two-tiered’ market where the average price: earnings ratio of the top 10 shares is 25.6 while the average of the bottom 10 shares is only 13.6. The market as a whole is thus expensive but this is distorted significantly by the top 10 shares on the JSE. In other words, if one looks further than the top 10 shares the conclusion of local shares being expensive, does not necessarily apply to all shares and that there are many shares that present buying opportunities. Although we would not expect the S&P 500 to be subject to similarly significant distortion, buying opportunities no doubt exist in the US as well. The crux of this argument is that stock picking skills are a key attribute to successful investment in equities the equity investor should look out for under current market conditions. Having concluded that the local and the US equity markets are on average expensive, without an unexpected shock to the financial system, we would not expect a major downward adjustment but rather an extended flat performance, once central bank intervention in financial markets ends. Until then, the equity market should still experience some tail winds.
At this stage an end of the monetary stimulus measures, other than in the US, is not foreseen for another year. As far as the other asset classes are concerned, cash currently returns a negative real interest rate. Bonds are sensitive to interest rate movement and these movements are most likely to be upwards and highly unlikely to be downwards. As the result bonds are currently not an attractive asset class and will remain unattractive until interest rate levels have normalized. This is also not foreseen for the next few years. Generally, global financial markets are due to move into the doldrums over the next year or two and will languish for an extended period until excess liquidity has been removed from the global financial system. Under these circumstances, we consider equities the preferred asset class and would maximise exposure to equities for the foreseeable future. Since the local equity market on average is expensive, international diversification into markets with superior growth prospects should be maximised. These are countries that were worst hit by the financial crisis and have not recovered yet as well as emerging economies. As we suggest above, stock picking skills are critical to investment in equities. A ‘safe play’ of investing in companies with superior free cash flows, high dividend yields and low P:E’s in industries that focus on basic consumer needs and perhaps in new technologies is what we would be looking for. Download the complete Benchtest fund investment overview for June 2014 and the Early Bird for July 2014 at http://www.rfsol.com.na/benchmark