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How do JSE returns turn around?

This is not just another market cycle.

The past decade on the JSE has played out in two distinct halves. The period from 2009 and 2014 was extremely good for local stocks, but the five years since have been dismal.

Investors can see this distinction in the longer term performance of local equity funds. Over the past five years, the top-performing fund has delivered around 8.5% per year. Over 10 years, the top-performer has returned 14% per year.

“If you look at the numbers, this past five-year period was bad in every possible way,” says Adrian Clayton, chief investment officer at Northstar Asset Management.

This is illustrated in the following graph:

Source: Bloomberg, Northstar Asset Management

The first set of bars shows that over the past five years the top-performing stock on the JSE was up 45%, compared to the biggest gain in the previous five years of 91%. Over the past five years, the worst-performing stock has lost 71%, while over the previous five years the worst was a 39% drop.

The median JSE-listed stock returned 20% over the previous five years, but only 3% in the past five years. And while only 58% of local stocks are in positive territory over the past five years, 83% were up in the five-year period before that.

So what’s next?

“It’s normal to have market cycles,” says Clayton. “But now that we’ve had five bad years, does that just mean that we are going to have five good years?”

The biggest reason to believe that returns from here will be better is that the market as a whole looks a lot cheaper than it did five years ago. In 2014 the JSE had become expensive on a price-to-earnings (PE) basis, but that is certainly no longer the case.

Clayton acknowledges that off this base, it is possible that the market could provide an improving return in the short term. The question, however, is whether that can be sustained, since it requires companies to justify improved ratings with growing earnings.

“I’m not in the business of predicting markets holistically, but when we look at South Africa and SA Inc, we are just deeply worried that companies are going to struggle to deliver high degrees of profitability,” says Clayton.

“Until we turn GDP growth around, we are going to be facing an uphill battle.”

He points out that companies in South Africa have already been though all sorts of ‘self help’ interventions. Many have degeared to try to strengthen their balance sheets, others have sold off underperforming or marginal assets, and a fair number have made acquisitions offshore.

“There has been a lot of movement, with management teams pulling all the levers they possibly can,” says Clayton. “They are all trying to address the same issue, which is poor growth.”

It’s the economy …

It is, however, very difficult for any company of meaningful size to outgrow their domestic economy. The graph below illustrates how nominal GDP growth and the earnings growth on the JSE are closely linked.

Source: Bloomberg, Northstar Asset Management

“There is actually a 12 to 18-month lag between nominal GDP and earnings growth,” says Clayton. “In other words, GDP leads JSE company profitability.”

Given that GDP growth has stalled since the start of 2017, he believes investors should expect earnings to follow it down.

“If this relationship continues to do what it has done historically – and I don’t see why it shouldn’t – then we are going to continue to see pressures on companies, because there’s not much more they can do,” Clayton says.

In his view, this means investors need to “navigate carefully” and work out what any company’s truly sustainable earnings are.

“Companies might look cheap, but there is the risk that their earnings continue to be under pressure,” Clayton points out. “So a PE of 10 might end up being a PE of 12 because earnings vaporise.”

With a number of management teams voicing their own concerns about the operating environment and how tough it is, investors would therefore do well to be selective.

“We are being quite cautious,” Clayton says. “We don’t mind owning certain domestic companies, but we just think you have to be very careful around those with poor balance sheets or who have a lot of leverage, because they are not in control of their own futures.”

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The MSCI Emerging Markets Index has been underperforming relative to the MSCI World Index since 2010. The JSE All Share has been underperforming against the Emerging Markets Index since 2016. So, we can say that the JSE is an underperformer among underperformers, almost like Bafana Bafana. The fact that the JSE has shown the same level of growth as the FTSE 100 over the past 6 years, is a light in the tunnel though.

The JSE outperformed the World Index on a Relative Strength basis until 2013. The JSE was a general outperformer until then. What went wrong since then? Well, the weak performance is due to a catastrophic confluence of disasters I believe. BEE is an enormous tax on businesses, but even more costly is the bad influence of BEE board members. Then we had the Eskom disaster, the anarchy of violent labour unions, the catastrophic Zuma period, the bankruptcy of municipalities, non-payment from government departments and corruption in the private and government sector.

Combine this with a business-killer income-tax regime, relatively high interest rates, redistributive municipal rates and taxes, the EE tax, the cadre-deployment tax, the high crime-rate tax and bad decisions from a socialist government, and you have a toxic combination of circumstances.

Additional to these internal disasters, we also experience a deflationary spiral on the international markets. The combined actions of Reserve Banks in first world countries practically mean that they export their deflation and economic contraction to developing markets. The USA prints the international reserve currency. When they push interest-rates down to zero in an effort to save the financial system, they also inadvertently push the profitability of all primary producers across the world down to zero. This transfer happens through the “search for yield” mechanism.

The bottom line is this – there was a time when our economy was strong enough to survive the ANC. That time is gone. South Africa cannot afford the ANC any longer. Their naivety, ignorance, incompetence and sheer criminality will bankrupt every business in the country.

Sensei, how do you feel about Ramaphosa, do you think he is going to bring this country back from the brink of rack and ruin?

I respect the man. I believe he is an ethical person. I also believe that as an individual, he is the best person for the job. That does not answer your question though…

I will answer your question with another question: Do you think, that if they include Lionel Messi in the team, that it will turn Bafana Bafana into a winning team?

Our president is also the president of the ANC. That puts him in a hugely conflicted position. Without the ANC, he is nothing. With the ANC in power, the country is nothing. When we reconcile these facts, it is clear that Ramaphosa will reduce his own legacy to nothing.

If he was to do the honourable thing, the right thing, the best for the country, if he had the welfare of the citizens at heart, he would simply join the DA or FF+ and confess that the ANC is rotten to the core. He chose not to do this. He chose to carry on with the lies and to pretend that he, or anybody in his party, has any control over anything.

I guess my answer is “no”.

HAH! And then Old Mutual says earlier this year that the JSE will outperform the average of the world markets over the next 5 years. Absolute rubbish. Have a look at the Old Mutual Investors fund-returns over the past 5, 3 and 1 years. Its their biggest fund. You have not earned more than the management fees of 2,28% any of these periods.
As I’ve been saying for 8 years now–get your money into asset swaps or better still, directly offshore.
I don’t know who Sensei is but he has a better grasp on things financial than most contributors to Moneyweb and other financial websites.
His summary this morning is spot on. The worlds biggest problem at the moment is not inflation, but deflation..something none of us have ever had to deal with.

Exactly the reason I cancelled my TFSA with OM. The fees mean negative returns on the investment.

Would be far better off leaving the money in the bank at 7%. OR better yet, offshore.

Much as I respect Sensei’s excellent assessment, it’s really common sense if you have been reading local and international media and attempting to trade your way out of this mess on the JSE in the last five years.

BBEE has killed the economy with (as he says) useless board members who have been put there to satisfy the myth of competence.

And regarding Dear Cyril: “Without the ANC, he is nothing.” Actually in the two decades or so of his being a recipient of BBEE he has a net wealth of some $400 million. That’s something …

I could go on …

want to agree with Magnus but I also dont think we will see great returns in offshore markets. My concern is short term gains on a macro level in SA…maybe we will out perform for 12 months…but then all the problems will bite again…Zuma with Ace and their control of commitees in government will manage SA..Ramaphosa is in trouble after today

Sensei for president, minister of finance & Reserve Bank governor! It’s as plain as day that none of us can afford to keep the current circus ringmasters in power. They that are supposed to be governing, do not have the ability to do so. They would rather bicker among themselves with their now blatant power struggles and factions being made with under the table dealings. Cyril beware; your own lot are going to do unto you as the Romans did unto Julius Caesar – they will plant a knife in your back (figuratively speaking I hope) and cast you aside. But I fear that all of the wisdom of the likes of Sensei and others will come to naught and the those that are running the country (into the ground) will continue their posturing and pillaging of what was once a great country to live and raise a family in.

It will be the economy that stabs the president in the back. The dagger will be delivered via the banking system. The banking system is the first to cave in under the enormous stresses of deflation and contraction of the economy. The decline in the value of all these assets we are talking about impacts negatively on the collateral held by the banks. Debt levels are rising at a time that the value of the collateral is under pressure. The pressure-valve is a sudden devaluation of the currency.

Government policy is unsustainable, BEE is unsustainable, The Mining Charter is unsustainable, the social grant is unsustainable, the public wage bill is unsustainable, the income-tax rate is unsustainable, the administered-price regime is unsustainable, the redistributive municipal tax regime is unsustainable, SOE’s and municipalities are unsustainable, government debt levels are unsustainable, our credit rating is unsustainable, our economy is unstable, employment levels are unstable, our society is unstable, asset prices are unstable, yet the banking system is stable? Come on…

Aah, but … corruption amongst the ruling cadres is sustainable, it seems.

Yet, when Maggie says this, what Sensei says, then many gun him down. Weird

Sensei, it’s the truth and nothing else but the truth!!!!!

The solution is that the ANC needs to split. The economy is not going to get up to speed before that happens. The unions and the left are blocking every positive move of CR.

Ideally, the ANC should have split at Nasrec, with CR and the “good” part joining up with the opposition, which would have gotten the country out of the economic policy stagnation and would have unleashed the energy in the economy.

However, if one looks at the new cabinet, you can see that the “unity” project is carrying on, so the cadres can remain on the gravy train.

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