Shaun Harris
Taking Stock
The swings and harrows of outrageous volatility that characterised the Johannesburg Stock Exchange (JSE) in the 18 months to early this year have smoothed out. Some stability, and the word is used with caution as globalisation has changed the rules for local equities, seems to be returning to the market.
To be or not to be in the equities market no longer seems a question. What must be decided is which sectors and classes of shares are expected to perform best under early signs of an economic upturn.
Improved fundamentals were in place at the beginning of the year, but not fully exploited except for the bravest of investors and fund managers, notably those who took a deep breath and plunged into commodity shares. They are reaping the benefits now – the rest of us, still jittery after Wall Street’s crack in September, were just plain scared of the market.
With interest rates still relatively high, money market funds were the place to be.
The June election also tended to put investment decisions on hold. Now that the election is behind us, it’s time to access the JSE again and take a view of where to invest.
Now here’s an interesting bit of JSE trivia. The calendar month of August last year, says Deon Gouws, head of research at Old Mutual Asset Management, was the worst month in the long history of the JSE. A calendar month may be an arbitrary measure of stock market performance, but it does indicate how volatile – and at times desperate – the equities market was last year.
Gouws believes much of the emerging markets’ heartburn is now out of the system. “The Asian crisis in real economies is not yet over, but stock markets are looking forward to recovery,” he says. One of the main reasons for the relatively strong performance of the JSE over the past six months, he says, is that the impact of the emerging markets’ crises was overdone on the local stock exchange.
But is this just a dead cat bouncing? No, it appears not. The rand has been more stable than many economists expected it to be, and the trend of declining interest rates seems firmly in place, at least into the early part of next year.
Gouws, backed by colleague Dave Tunnington, believes most commodity cycles bottomed around about March and are due for further re-rating. The obvious exception is gold, the downgraded metal threatening a devastating impact on employment in South Africa.
Unemployment, accelerated by the low world gold price and possible closure of mines in this country, is our biggest problem at the moment. But the overall effect of bullion on the local economy needs to be put into perspective. Gold currently accounts for less than 20% of exports, compared to nearly 40% in 1990, and only contributes about 3% to South Africa’s gross domestic product.
The low gold price certainly carries a high social cost, but should not affect economic fundamentals like interest rates or most sectors of the equities market.
Gold certainly does not seem to be dampening prospects for the local bond market, where the yield on the R150 government bond looked like it could fall through 14% earlier this week. Strong foreign buying of local bonds should keep the yield low over the short term, making it an attractive investment at the moment.
But with interest rates coming down, equities are probably the place to be. Sectors that most fund managers feel particularly buoyant about over the next one to two years are resources, though these shares are always volatile and those investing now may have missed a large part of the run-up, and consumer stocks, not yet reacting fully to lower interest rates but bound to start firming up soon.
Investors with more appetite for risk could also consider what are loosely called growth stocks, those companies, both big and small, that have shown or appear capable of above average earnings growth but have been downrated as market volatility saw a flight to the old blue chips.
The most potential for strong performance here seems to be the smaller companies, the small caps, ravaged by the earlier downturn and currently on low ratings.
The problem here is one of stock selection. More than 400 shares on the JSE probably fit the definition of small caps, and they are spread across different sectors.
Apart from the obvious venture and development capital shares, sectors to look at for potentially rewarding small caps are probably information technology and electronics and electrical, financial services, particularly the smaller banks and asset managers, and retail, maybe furniture and appliances as well.
It’s a tough call for those investors planning to go directly into equities because of the wide selection. The low-priced penny stocks are an option, but only with money that is truly disposable. Risk here can be high.
Otherwise, the IT stocks are probably the place to focus on for share selection. A lot of organic growth is expected from these companies, and in most cases the shares have been sharply downgraded and are offering value. As a sector, IT could produce the best performing small caps for the rest of this year.
If you choose the right shares returns will be great, but just one dog can hamstring the portfolio. So specialist unit trust funds are a safer option.
The Board of Executors, Investec, Coronation, RMB and Old Mutual offer focused small cap funds. Nedcor Investment Bank, Old Mutual and Investec Guinness Flight have some of the top performing commodity and resources funds.