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Is this 2002 for SA investors all over again?

The similarities – and the one big difference.
One thing that has changed is the state of the local economy. Image: Shutterstock

At the start of 2002, South African investors could be forgiven for feeling confused. The previous five years had produced a remarkable sequence of returns on the JSE.

As the table below indicates, after two years of going backwards due to the emerging markets crisis, the FTSE/JSE All Share Index (Alsi) surged with the internet boom in 1999, only to come back to earth in 2000. In 2001, the local market rose sharply once again, defying the fall in global stocks as the dotcom bubble burst.

FTSE/JSE All Share Index returns by year
1997 -4.5%
1998 -10%
1999 61.4%
2000 0%
2001 29.3%
Five-year annualised 12.4%

What was even more at the forefront of investors’ minds, however, was the performance of the local currency. In this same five-year period, it had blown out from under R5 to the dollar to R12.40.

At the height of this extreme movement in the exchange rate, many South Africans were rushing to get money offshore. Spurred by the belief that the collapse in the rand was irreversible, they believed the best way to preserve their wealth was to get it into hard currency. That meant abandoning the local market.

Gaining perspective

There were however a number of local investment professionals arguing that this was not the right course of action. It didn’t fit with the fundamentals – most obviously the difference in the prevailing price-to-earnings (PE) multiples between the local and US markets.

“The S&P 500 average PE was over 40 times at the time,” notes Adrian Clayton, chief investment officer at Northstar Asset Management. “This meant that at the rate at which companies in the US were growing their profits, it would have taken an investor 40 years to make back the money invested in that market. In addition, many US companies were on elevated profit levels, adding a risk that these would falter.

“By contrast, the majority of high-quality South African companies in 2002 could have been purchased on depressed yet rising levels of profitability and on PEs below 10,” he adds.

“This meant that in a ‘worst-case’ outcome, an investor’s payback period was only 10 years.”

This was however largely being lost in the fear around the currency. Yet a rational analysis of the rand should have given investors something to think about as well.

“In 2002, the rand reached a level of R12.50 to the US dollar, but based on purchasing power parity [PPP], should not have exceeded R7,” Clayton notes.

As the graph below shows, the blowout in the currency was clearly overdone if one considered this measure.

Source: Bloomberg and Northstar Asset Management

The streak

What happened next is now a matter of historical record. Although 2002 was a disappointing year on the JSE, from the start of 2003 the local market went on one of the greatest five-year streaks in its history.

FTSE/JSE All Share Index returns by year
2003 16.1%
2004 25.4%
2005 47.3%
2006 41.2%
2007 19.2%
Five-year annualised 29.3%

To put that in nominal terms, an amount of R100 invested in the Alsi at the start of this period would have grown to R430 by the end of it. Over the same time, the rand strengthened back to R6.80 to the dollar, seriously denting the wealth of many investors who had been unfortunate enough to go offshore at the wrong time.

This outperformance of local assets also continued for another five years.

“The Alsi gained 400% from March 2002 to March 2012,” Clayton points out. “Comparatively, the S&P 500 returned 65% and the Nasdaq 121% in US dollar terms. Investors failing to grasp the unique opportunity in South Africa incurred a decade of significant negative currency effects, while simultaneously being exposed to equities which grossly underperformed a rampant JSE.”

Is history repeating itself?

The parallels between where we were in 2002 and the current market environment are obvious. The US market is looking expensive, the JSE is depressed, and the rand is cheap on a PPP basis.

“Current PE multiples generate a distinct sense of déjà vu,” says Clayton. “However, there is a significant difference between the two periods.”

That is the state of the South African economy.

In 2002, South Africa’s GDP growth rate was 3.7%, which was healthier than the growth in similar commodity-producing economies Brazil and Canada.

“The real economy was robust, systems of government were operating smoothly, companies were investing, consumers were spending, and hope was high,” Clayton recalls.

This is certainly not the case today. South Africa is barely registering positive real GDP growth, and that has implications for local businesses. As the graph below shows, earnings on the JSE have historically followed the performance of the economy.

Source: Bloomberg and Northstar Asset Management

What should investors be thinking?

This means it is harder to rely on a statistical measure like the market PE  because company profits cannot be relied upon. As Truffle Asset Management portfolio manager Saul Miller pointed out recently, the opportunity on the JSE cannot be viewed in the same way it has historically because the environment is structurally different.

Read: How much is history still a guide when looking at the JSE?

For Clayton, this leaves investors in a conundrum.

“The numbers indicate that South African assets are preferable versus offshore assets,” he says. “But it is clear that traditional valuation frameworks are being rendered increasingly irrelevant by the tectonic economic shifts in South Africa and current dire state of affairs.”

In this environment, prudence remains the best approach.

“Essentially our view is that it is difficult to argue against finding a balance,” Clayton says. “We are convinced that a portfolio of both domestic and offshore assets makes more sense than ever.”

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Those were good times.

I can recall buying Anglo at R120.00 per share somewhere around 2002/2003 and sold it somewhere in 2005 at R518.00. Only two or three years later.

Important to note that 15 years later it has not recovered to that level.

Somehow I dont have the same enthusiasm to invest locally this time.

What do you mean?

In 15 years’ time it will be worth R518 000 000 000 000 per share.

Problem is that it will be at R1 000 000 000 000 000 000 to the dollar.

In 2002 we do not have the de industrialisation THROUGH BEE and rampant corruption through theANC that we have now.

South Africa runs a “false” economy in terms of local stocks and shares. Our market is driven by forced demand and supply. Contemplate this.

Every lathe corporate in SA has some form of provident or pension or retirement fund plan whatever you want to call it. These plans are typically compulsory and usually in the guise of employee contribution plus employer contribution. These compulsory deductions are made every month (I am sure that some clever expert can calculate the exact monthly total contribution in the country) suffice to say it’s hundreds of millions. These deductions go to fund managers for investment purposes and herein lies the problem. With the restriction of overseas investments and all the other rules regarding these funds, the majority of these funds are forced into the SA stock exchange. This is creating the supply and demand purely due to the fact that fund managers are running out of places to invest in SA.

This monthly inflow or annual inflow is creating the PE ratios we see today. In 1995 no one would invest in a company with a PE of 30 or more. Today this number is common and no one even mentions them. Fund managers are hampered by legislation and the onslaught of ETF products which blew through the R100 Billion mark.

Unless there is a relaxing of some of this legislation, we will see that in the not too distant future, most companies will be owned by these funds.

…and I fear, it is exactly this “compulsory” monies (standing at R6-trillion), which will save Eskom’s multi-billion dollar debt (plus that of other SOE’s).

I’m looking forward one day to receive my state”IOU” bill from my fund.

(Or govt debt could be ‘kindly’ paid by China, in return for owning some of SA’s strategic assets, like our Port Authorities.)

There is another dimension that we should keep in mind. There many drivers of the profitability of local companies that depend on local circumstances, but certain external factors underlie all local profitability factors. In other words, when this external factor causes the tide to rise, then all boats in the harbour rise to the same extent.

This tide, that determines the level of all boats, is the Dollar Index. This is the exchange rate of the US dollar against a basket of currencies. Emerging markets outperform the US market and the MSCI World Index when the dollar trends weaker against the Dollar Index. Emerging Markets outperformed by 280% between 2002 and 2008 when the dollar weakened by 86%. The JSE was the leader of the pack during this period of outperformance.

The dollar strengthened by 53% since 2008, driving a 50% underperformance of emerging markets over that period. The tide was going out for us over the last decade, and it is spring low for us at the moment. The movement of the rand, in particular, does not influence this tide.

The tide is turning though. Trump will throw tantrums until the dollar goes weaker and the Chairman of the Fed is monetizing the government debt(printing money). The technical setup confirms that the tide is turning. The JSE is entering a decade or more, of outperformance again. Just remember to put on the sunscreen and the life-vest, and enjoy the ride!

From a technical point it looks as though The Alsi40 bounced of the 80 period MA a year ago but with quite a bit of heavy resistance ahead.

Alsi 40 above 55000 then maybe another look?

My 2 pence.

On a Monthly chart. Sorry.

I always pay attention to you posts, as you are, imho, one of the wise ones on this platform. Is it purely a case of technical ? Does the unemployment, power issues, government debt etc, not have a major impact? Are markets and reality always/mostly out of sync ?

Thank you. I have got skin in the game times three. This motivates me to determine the real drivers of share performance. If I am wrong in a major way, I pay dearly. I am wrong regularly, but only in minor ways, luckily.

It is quite normal for emerging market economies to suffer from the kind of troubles you mention, during times of dollar strength. The disastrously inept and corrupt socialist ANC government does compound our problems, of course. In 1982 we saw the Mexican Crisis, followed by the Asian Crisis of 1997, the Russian Financial Crisis of 1998 and again in 2017. Those crises happened due to dollar strength. South Afrika is in a minor financial crisis at the moment, partly due to the stupidity of the average voter.

The US dollar is the major reserve currency for emerging markets. This allows the US to export their inflation to emerging markets during times of dollar weakness, and to export their deflation and economic contraction to emerging markets during times of dollar strength. Trump thinks he rules the world, well, as a matter of fact, he actually does.

@Sensei your analysis makes sense, Bloomberg commentators also have a view that the dollar will weaken going forward. I am one of the investors that got slightly burned in 2002 when the USD temporarily reached R12. Fortunately those investments have recovered and are doing ok now.

As someone who needs a bit more protection from the ANC my thinking is currently that if emerging markets are entering boom years then better to invest in an emerging markets equity fund and not too much on the JSE. This provides currency protection as well.

PPP is a poor basis for valuing the currency. Five years ago on 17 Jan 2015 the R/$ was 11.55. So that represents an annual compound devaluation of about 4.4% which may be less than the interest rate differential for low risk bonds between the US and SA. So the rand situation prior to 2002 is not mirrored here. If anything the Rand looks stubbornly overvalued given the local debt and economic outlook. Apart from mining which works to a different resource rhythm which sectors locally are the ones poised for growth?

There is simply no more value in the local market. Local fund managers are slowly turning into estate agents. “It’s the best time to buy!”

No, it’s not.

SA economy is slowly crumbling. Junk status in March. Massive capital outflow to be increased exponentially until guavament closes exchange controls.

Have a look at all the layoffs happening right now in private sector.

Look at the mess at:
Eskom
SAA
Prasa
Denel
PetroSA
Post Office
SABC
SABS
SASRIA

All made losses in 2019

Get your money out of SA NOW before it’s too late.

‘Local fund managers are slowly turning into estate agents. “It’s the best time to buy!”
Nonsense. Most established ‘local’ managers have a range of offshore domiciled funds which they would be more than happy for you to invest in. That goes for Northstar too.

This myth that ‘local’ managers are somehow colluding with government and hell-bent on stopping you from investing offshore is one happily spun by Magnus and others desperate to position themselves as maverick sages. But it’s nonsense. They have to comply with Reg 28 in the relevant Retirement Funds, but they certainly don’t relish doing it and most have been at the absolute offshore maximums for years too. There’s also nothing to stop you investing in their non-Reg 28 funds, they all run global flexible funds too which are not capped in any way.

You may well be right that Fund Manager are investing offshore – unfortunately they are using Rand to buy into the overseas markets, and on sale in the future the funds have to be returned to the Rand monetary area – so if there is growth overseas then you will gain in Rand terms when you as a RSA citizen sells out of that fund – you are not permitted to keep you portion of the fund in an overseas account. Also as a RSA citizen try and open an overseas account whilst still living in RSA – not possible

I understood that quoted comment to be sarcasm.

He’s probably suggesting that because our share prices are on such low PE multiples. Another big difference is the power situation, if companies are allowed to self generate then there will be a huge comeback! We also have another boom from Commodities which was the same in those years! This may well be the best time to invest!

Just because somethings selling at sale price doesn’t necessarily make it a deal.

Mechanism making wonders come true. Knowing the root of profit, loss, or whatever, gives someone a head start. Except the gambling ones scoring big time, giving credit to own thinking capacity. The rest, all bull. The fairy tale making dreams come true is a bank named reserve. Knowing moves, any idiot can profit. Not, it is, with hindsight,luck, B.E, or heaven at work.

Q.easing. and the usual globally local idiots with nicknames like entrepreneur, disadvantage, or whatever, believing they can see clearly now.

For as long as I have been on this planet, I have been hearing that Rand is undervalued. My only conclusion is that this will continue.

Just because something is undervalued or overvalued, does not suggest that it should revert to some sort of mean or expectation, is such may exist.

It likely means that the measurement system is wrong. Like the rubbish hamburger index that journalists are so fond of quoting.

This is a very good article report, period!
I have been involved in the FX Corporate treasury market and still follow it daily after I retired.
I don’t want to generalise and accuse fund managers, analysts, economists etc. of basing lots of their investment advice – on the weakening of the Rand. A plethora of these analysts, like Magnus Heystek, is beating this drum for years now. Question is : What percentage of these offshore investment profits are made with ‘’the weakening’’ of the Rand against most major currencies?
I also seriously question these ‘’types of currency advices’’ under the FAIS Act – are they FAIS compliant to start forecasting and advising on exchange rates? Thera is a very specific section on this.
And, what about the losses on these investments when the Rand actually depreciates against these major currencies, like it has been doing in 2017 to 2018 – and also last year from USD/Rand 15 to 13.85 I posted this question on another very good article ‘’ Exploding interest payments ? Blame Zuma, by Mike Schussler.
I think lots of analysts must remember that a plethora of their clients are close to their sell by dates and or already on pension.
These investors just cannot take that currency risk and cannot rely on the ‘’analysts now turned FX dealers’’.
Shorter term investors should rely on the return of the global portfolio that is linked to the price index return (excluding any dividends) of 100% EuroStoxx 50.
The return of the index in its base currencies is considered and Rand depreciation or appreciation against these currencies will not impact the value of this investment (i.e. no currency risk). The returns are provided in South African currency and will not be affected by changes in the rand exchange rate.
Your initial capital invested are guaranteed and if the investment ends up with a negative return – you still end up with your growth investment amount – this is the type of risk that I think a 5 year offshore investment should carry.
There are products like this – Glacier Vantage Plan, Glacier Capital Enhancer investment option.
The Glacier Capital Enhancer investment option is a five-year investment that provides capital protection as well as an enhanced return with uncapped upside linked to a global portfolio. The Glacier Capital Enhancer Investment option is set-up in the Glacier Vantage Plan, a sinking fund policy underwritten by Sanlam Life
Insurance Ltd (Sanlam Life) and administered by Glacier Financial Solutions (Pty) Ltd.
Factors affecting your return
The investment return and the capital protection are provided by investments with a leading global bank namely BNP
Paribas. The leading global bank has at least a long term credit rating of A+ from Fitch.
While only a bank with a high credit rating is selected for provision of the capital protection and investment return, the maturity benefit can be reduced in the unlikely event that the bank should default.

Hi – anybody home?

I am still here. Just went out for a moment to feed the dog. Sorry.

End of comments.

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