Local investment buoys JSE

The performance of the JSE so far this year, which hit yet another all-time high during the week, has been in stark contrast to myriad challenges faced by the domestic economy and in spite of a sell-off of shares from foreign investors in recent months.

A number of issues weigh heavily on the South African economy. Most notably is Eskom’s inability to keep the lights on, which has led to stern warnings from international institutions and resulted in both the World Bank and the International Monetary Fund this week cutting their growth forecasts for the economy to 2% for the year.

Following a fairly steep increase to account for more than 40% of the stock market’s ownership, the appetite of foreign investment on the JSE equities market had mellowed somewhat in recent months. Yet the JSE all share index climbed to a record high of 53 420 index points on Monday.

“Foreigners were very large net sellers of South African equities in the past month or two, yet the index continues to rise. It tells you South Africans are on the other side taking up what they selling. The only way to read this is as higher local buying appetite,” said an equities analyst who wished to remain anonymous. “South Africans are quite equity heavy compared with our peers – we have an equity culture.”

Indeed, it is domestic investment – thanks to legislation which keeps most South Africans’ savings within the country’s borders, and more often than not in the JSE – which has helped buoy the exchange, as the domestic life industry and collective investment schemes continue to grow.

Total household financial assets tallied to R6.8-trillion at the end of the third quarter of last year (accounting for 70% of R9.8-trillion in total household assets), according to Johann van Tonder, an analyst at Momentum. The bulk of this is invested in the JSE which, at the same time last year, had a market capitalisation of R10.7-trillion according to World Federation of Exchanges data. This has grown to R11.2-trillion in March this year.

According to the latest Momentum/Unisa South African household wealth index for the third quarter of last year, the bulk of household assets are invested in listed shares on the JSE, and done so largely through investments in retirement funds.

Encouraging legislation
It’s not just good returns which have continued to see household investments channelled into the JSE whose all share index achieved a 10.9% return in 2014. But legislation has encouraged investment in equities too.

Regulation 28 of the Pension Funds Act requires no more than 25% be invested offshore; a maximum of 75% (the highest allocation) may be invested in local listed equity – the JSE. A limit of 25% is prescribed for property investment; a maximum of 100% in cash is permitted.

“Pension funds are allowed to invest a significant amount of their funds on the JSE, but they generally have money in other asset classes. Generally a fund would have between 50% and 60% invested on the JSE,” said Dinesh Munu, a partner at Deloitte. “Of the 25% which can be invested offshore, there are further limits as to what portion of this can be listed or unlisted.”

Pension fund flows and household investments account for many flows into the exchange, said Munu. “If you add the government employees pension fund [managed by the Public Investment Corporation], it becomes a significant shareholding.” The corporation, according to the JSE, is the exchange’s largest owner, accounting for some 10%, at last count.

Munu said South African regulation in this regard is “very rules-based in that it says you have limits of what you can and can’t invest in”. Some global laws, however, are instead principle-based for prudential investing, he said.

As such, pensions and other financial assets have behaved as a natural anchor for the performance of the JSE, the anonymous analyst said.

Life industry
South Africa’s life industry is one of the largest in the world, according to a 2014 KPMG report on the domestic insurance industry: “According to the World Economic Forum’s 2013/14 Global Competitiveness Index, on a per capita basis South Africa is ranked third in the world [out of 148 countries] in terms of financial market development behind Hong Kong and Singapore,” and its life insurance penetration rate is amongst the highest in the world too.

According to the Association for Savings and Investment South Africa’s 2014 statistics on collective investment schemes (which comprises instruments such as unit trusts), “for the first time in many years investors favoured a higher equity exposure within their investment portfolios in 2014, despite the volatility in the local equity market.

“The JSE all-share index achieved a 10.9% return for the 12 months ended December 2014,” the association said in a press release. “Out of the R101-billion of net inflows to the multi-asset sector in 2014, R65.5-billion went to high equity portfolios. In addition, the SA equity sector attracted net inflows of R16-billion in 2014 , the highest in over 10 years.”

Analysts have long-warned that the price-to-earnings ratios on the JSE have also been fairly high. With an average ratio of around 18, it is considered historically very high.

The ratio is the share price of a stock compared with its per-share earnings and typically signals investor confidence in the stock.

It has been pulled up by the likes of Naspers which, thanks to having a substantial 34% investment in Chinese investment holding company Tencent, has a stratospheric price-to-earning ratio of 108. The soaring price of Tencent, too, is what helped push the JSE to record highs on Monday.

But domestic investment funds have also played a role in keeping price-to-earning ratios high.

“It’s a self-fulfilling prophecy,” said the unnamed analyst. “Policy encourages a long-term bias and an equity bias long term, so regardless of extended earnings multiples we see steady purchasing coming through.”

Rand weakness
Wayne McCurrie, portfolio manager at Momentum Wealth, said the JSE’s current valuation level has not been determined by what South African investors have been doing.

“Probably 60% or 70% of our share market is in fact the overseas price of shares translated back into rands,” he said. “The main reason why our share market has truly done so well – the biggest single reason – is rand weakness. Our share market itself is a very good rand hedge … The point by and large is that the share market is a global share market and not truly reflective of what’s happening in the South African economy.”

Foreign ownership of the share market has also been steeply increasing, McCurrie said, noting that roughly 60% of mine shares are owned by foreigners and about 45% of industrials too. Foreign investors have also favoured local retailer shares of late.

Domestic players have been buying banks and other financials in the past three or four months, said McCurrie. “And the financial index is the best-performing index this year so far.” As such price and earning ratios have been pushed up from about 12 to about 14.

While companies would seek deep capital pools in the markets they choose to list, McCurrie said it was unlikely to be the reason why multinationals are on the JSE.

“The liquidity in our market is peanuts compared to overseas,” he said, noting that Glencore is the only dual-listed company that doesn’t have some major historical ties tracing back to South Africa.

South African bonds start to look attractive for investors

Foreign investors are buying South African bonds at the fastest pace on record in April after spurning the nation’s debt for two months.

Foreigners have bought a net R14.2-billion of South African notes since the beginning of the month, according to JSE data. That’s the biggest two-week inflow on record and on course to exceed the R14.1-billion that was purchased in the whole of September 2013. Foreigners sold a net R16.4-billion of the debt in the previous two months.

With yields in Europe and the United States at or near record lows, investors are looking elsewhere for returns amid speculation that the Federal Reserve will delay raising borrowing costs to bolster the US job market. South African bonds, which yield the most among 24 emerging markets after Brazil and Turkey, are a good bet even as power outages weigh on economic growth and workers demand pay rises above the inflation rate, according to Cape Town-based Cadiz Asset Management.

“After two months of very poor returns and the significant sell-off in our bonds, we started looking attractive,” said Jonathan Myerson, who helps manage about $2.2-billion as head of fixed-income investments at Cadiz.

“Some soft data in the US and Fed talk, which gave the market an indication that maybe the Fed rate hike will be delayed slightly, just brings back the search for yield.”

Yields on benchmark South African securities maturing in December 2026 climbed 67 basis points in February and March, reaching a 10-week high of 8% on March 13, as investors sold emerging-market assets in anticipation of rising borrowing costs in the US. Since then, the yield has dropped 24 basis points as weak US jobs and retail sales data prompted investors to reconsider the timing of rate increases.

“We saw a resumption of risk appetite and we actually saw a lot of that flow return back to emerging markets,” said Mohammed Nalla, head of strategic research at Nedbank.

“There’s still this global search for yield because the market anticipates rates are going to probably stay lower than they had anticipated for a little bit longer.”

Investors are more focused on international rates remaining low than South Africa’s power shortages or labour strife, Myerson said. “In this global environment that becomes secondary,” he said. “Any indication that Fed rate hikes are not as imminent as they were considered to be only a month ago” makes South African bonds relatively good value, he said. – Xola Potelwa © Bloomberg