At the beginning of the year we said that we were pro equities — not because we were necessarily bullish, but because the environment at the time of low inflation and low interest rates, fuelling a rampant consumer, was more conducive to equities than bonds or cash. The 2,1% decline in the all-bond index for the first six months of 2006 clearly illustrates this point.
A first-half return for 2006 of 18,8% on the JSE all-share index, however, suggests that 2006 could be another bumper year for South African equity investors. Once again the market was led by resources (up a massive 36,9% for the six months to June!) with financials and industrials slightly off. That stellar performance is, however, misrepresentative of “play” during the first half of the year, because, as we know, the equity market has been a lot less “certain on its feet” than it was for the past couple of years.
Two things have changed since the beginning of the year.
Firstly, Alan Greenspan, chairperson of the United States Federal Reserve, handed over the reins to Ben Bernanke after 18 years at the helm. Greenspan was subtle; Bernanke is direct. When you’re used to 18 years of subtlety, directness can be scary, particularly when it involves further rate hikes in a war against inflation.
Secondly, 4%-plus interest rates prove alluring to money managers in terms of yield, and this — coupled with a fear of what would happen to global economic growth (and the effect this would have on emerging markets) if Bernanke kept raising rates further, which he said he may well do if necessary — meant that the 17th US rate hike soured investors’ attitudes towards emerging markets. We were punished alongside the rest of them, particularly those with large current account deficits.
The South African equity market leapt out of the starting blocks during the first few months of this year, and by the end of April was up roughly 18%, a level that clearly was over-exuberant. The subsequent correction (both in the rand and equities), while highly predicted, was also overdone and therefore positive long-term fundamentals saw buyers return to the market.
From the rand’s perspective, at 11,7% off for the year against the dollar, this is in line with our gradually weakening scenario and we don’t expect further weakness this year.
So, at half-time, on a return of roughly 19%, the all-share index is probably still slightly ahead of itself and we would look for a more pedestrian second half.
Looking ahead, though, equities should be supported by solid fundamentals and the currency by commodity demand and a structurally challenged dollar. In addition, Bernanke — although more careful about how he words things — is keeping his finger on the interest-rate trigger.
A cautiously optimistic tone would therefore be advised. Don’t avoid equities, but vary your consumption thereof based on how much risk appetite your stomach can digest.
Jeremy Gardiner is a director at Investec Asset Management