I had a very interesting conversation with Paul Hansen, director of retail investing at Stanlib, about the apparent disconnect between the JSE and the economy.
While we are being warned by economists about a possible economic recession, the JSE All Share Index continues to surge to new highs. How is it possible to increase the value of companies when the economy is plunging?
Hansen points out that currently, offshore earnings account for around 50% of the earnings of the All Share Index so for many of South Africa’s large companies, our growth is less relevant than the growth of the global economy.
You just have to think about some of South Africa’s giants dominating the Top 40 – most mining companies, especially the likes of BHP Billiton, have predominately offshore earnings. Richemont and British American Tobacco (BAT) earn almost all income from offshore operations. Even SAB Miller has nearly 80% of its income generated abroad.
Most of our retailers, banks and telecommunication giants have an African footprint and are seeing strong profits from these markets as sub-Saharan Africa grows at 6% a year.
Little correlation between earnings and GDP
Hence, Hansen argues, many South African companies’ earnings show very little correlation to our GDP. He uses earnings generated by the Financial and Industrial Index (FINDI) to make his point:
In 2012 the FINDI grew its earnings by 20.5% while the economy grew in nominal terms (including inflation) by around 7.5% – nearly triple the rate of economic growth
In 2013 the FINDI grew earnings by 14.1% while the economy grew by 7% – earnings were double the rate of economic growth. This year so far the FINDI’s earnings are over 8% but it is the resource shares which are delivering the earnings performance this year with earnings so far of 19% despite the ongoing platinum strikes.
Hansen also makes the point that economic growth in other countries does not necessarily translate to market performance. Despite an incredible growth rate, investors in Chinese listed companies have had a virtually flat return since 1997. Hansen says investors simply do not trust Chinese corporate governance nor the Chinese government which owns large stakes in most Chinese companies. South African companies in contrast are well respected and their corporate governance is the highest rated among emerging markets – investors have a good idea of what they are investing in and they like transparency.
Valuations becoming concerning
While this explains why our stock market continues to grow despite a weak economy, the valuations are becoming concerning and Hansen says after a six-year bull run, it would not be a bad idea to take some cash off the table especially if you have a shorter investment time frame. At the very least, this is perhaps not the time to invest your nest egg.
Just an interesting observation: if you compare the performance of the JSE All Share Index since the bursting of the dot.com bubble in 2000 to the World MSCI, you find that the JSE is up 298% in dollars (10.2% compound return per annum in dollars for 14 years excluding dividends) whereas the MSCI is up just 29% in dollars (1.8% per year for 14 years).