How far can it go?
The question that is top of mind for most investors is how long the stock market can continue to grow after the crash of 2008/9. Some people are concerned that our stock market cannot increase further and perhaps it may drop back to the low levels seen in March 2009. As with all questions relating to investments, it is impossible to make any concrete predictions but one can look to the past as an indicator of possible outcomes. Short historical periods are meaningless but longer periods (20 years or more) can provide some useful guidelines. Anil Jugmohan from Nedgroup Investments did some great analysis of post bear market returns on the JSE. He analysed all the crashes from 1900 to date where the market fell by 20% or more – the results of which provide some very interesting insights into the length and strength of a stock market recovery after a major crash.
Two categories of recovery
No two stock market recoveries are identical however there are two broad groupings of recoveries that are distinguishable by the length of time they took to recover all their losses. These can be broadly divided into two and four year recoveries (please note the number of years is an indicator only, the periods were not exactly two & four years respectively). This means they took two or four years to get back to their peak pre-crash levels. Before the most recent crash, the JSE was at its peak in May 2008 so we are still a few months short of the two year mark (the first grouping) and we are still below our pre-crash levels (approximately 33 000) The recoveries that took four years or longer were all pre-1980 whilst the quicker recoveries have mostly been more recent ie, after 1980. If you were to graph these categories of recoveries, the quicker ones look like the letter “V” whilst the slower recoveries look more like the letter “U”. All of the recoveries took place with some significant setbacks during the recovery period. Generally all of them recovered then fell before recovering again – sometimes the cycle was repeated two or three times. The current recovery seems no different as indicated by the significant stock market drop of last week .
What can we learn from all of this?
All stock market recoveries are unpredictable – just like the crashes that precede them. We cannot be sure of how they will turn out, which means we need to take all “forecasts” with a pinch of salt. As an illustration some of the most illustrious South African fund managers are saying that our market is looking expensive and is probably due for a fall. History tells us that one needs to balance this view with a broader perspective. The diagram below shows graphs of all the JSE recoveries after a fall of 20% or more. It is a busy diagram with many graphs but the general trends are far more important than the individual details. The graphs show the market performance from the point of a 20% loss ie, not from pre-crash market highs. The current recovery is indicated in red. When compared to all the other big crashes of 20% or more, it is clear that the JSE can move substantially higher from these levels. In addition the recovery can last for many more months or even a few more years.
Source: I-Net, compiled by Nedgroup Investments
I am not suggesting that you become a blind follower of historical trends however, you need to have an awareness of previous recoveries so that you can make informed decisions going forward. The fact that the JSE has had a significant recovery already and may be trading above its long-term average PE ratio does not mean that it will fall from here. Just as the market fell too far in 2008/9 it can move much higher from these levels into expensive territory.
What is likely to drive our market this year?
It does not take too much insight to realise that our market is still being moved by international markets. It is likely that our local fortunes will be determined by international events again this year with local factors having little influence. If international markets have a bumper year, we will most likely have a great year too. If the international markets stay flat or drop, we could see a fall but perhaps not to the same levels we saw in 2008/9.
One also needs to be mindful that the volatility of recent years may continue unabated this year. As an indicator, in the 1990s the Japanese market had four jumps of 50% or more while their economy was in a major long-term recession. This means you need to ensure that your investment strategy can tolerate major swings over the next few years. It also means that economic growth may not be the driver of a market recovery, over the short term it could be the hopes and fears of irrational investors. It is impossible to insulate a portfolio against volatility – my suggestion is to focus on traditional businesses that pay good dividends and have a sustainable business model. I certainly won’t be rushing to buy any new listings and I will favour larger companies over small companies in 2010. If you are not a stock picker then you should look at ETF’s that track the Swix or high dividend paying shares.
*Warren Ingram, CFP®, has been advising people about their money management since 1996. He is a director of Galileo Capital, www.galileocapital.co.za.
Are there specific Money Matters you would like Warren Ingram to cover? Write to him at Warren@galileocapital.co.za