Prudence needed on Pricey JSE
From Sunday Times 1 May 2005
By James Frater, Managing Director, Frater Asset Management
It is one of those ugly times when professional investors are
battling to find opportunities in financial markets.
Interest rates are low, most asset classes are expensive, and there
is a great deal of uncertainty in the world, brought on by, among
other factors:
These issues have been around for a while. The bad news is that there is a deterioration in most of the key indicators.
On the domestic front there are also a number of concerns: the strong currency; low interest rates; and the current account deficit.
The rand is strong because of high global commodity prices. With terms of trade favourable and more cash than ever in our pockets, South Africans en masse have acted like a kid with credit at the school tuck shop.
We have spent and spent and spent – on houses, cars, holidays, DVD players, you name it.
As a result, we have rung up the second highest current account deficit in US dollar terms in our history – and what’s more, it is still growing rapidly.
Happily for South Africans, foreign investors are currently prepared to fund this deficit because of South Africa’s strong democratic institutions, sound central bank policy and modern banking system.
However, one must remember that it is really the rand that is keeping inflation under control, not the Reserve Bank’s inflation targeting.
Commodities and portfolio flows are maintaining the rand’s strength. Both could just as easily reverse.
South Africa is predominantly a resource-based economy. The country’s main net exports are gold, platinum, diamonds, coal and ferrous metals. But commodity pricing tends to be cyclical in nature, which makes the economy prone to boom-or-bust scenarios.
The last time the current account deficit rose so high was in 1981, after the big precious metals boom of 1979/80.
The aftermath was horrible: the gold price dropped, the economy slowed and the rand weakened, culminating in a low point after the infamous Rubicon speech of 1985.
People will argue that “this time it’s different” – but expressions like “this time it’s different” have usually been followed by the most hideous unrecoverable losses in market history.
The laws of economics must come into play to normalise the situation. This is likely to lead to a weaker currency, and/or higher interest rates.
We have accordingly migrated a portion of our portfolios away from the interest rate-sensitive domestic economy into exporters and other rand hedges.
The chart shown here is quite interesting. Essentially, it is the All Share Index in real terms with a trend line running through it (the dotted line). There are 25% markers on either side (the solid lines).
The market is currently above the trend line-plus-25% level, which indicates that the All Share Index is expensive relative to itself, and that there will be opportunities in future to buy it at cheaper levels.
One may look stupid in the short term (as was the case in 1967), but, in the long run, such prudence usually pays off.
As the US writer Norman Cousins once remarked, “history is a vast early warning system”.
Markets are at levels where one generally does not make money.
There will be opportunities to make money from the equity markets in the future.
Why risk the good gains that have been made over the past few years?