While an array of factors interact in an equity market phase, bull markets are primarily driven by:
- An actual or expected surge in earnings.
- Cheap starting valuations (usually after a major collapse) – investors are bargain hunting and eventually drive up demand.
- Nothing (a false bull market) – markets rally and then collapse.
All Share Index (Alsi) bull markets since the 1960s have been driven mostly by earnings surges. The timing of the market reaction to the surge in earnings varies. Mostly, it starts going up before the earnings surge (i.e. in anticipation of the surge).
Of the nine bull markets in the last 55 years, six were driven by earnings surges (red arrow), two were driven by starting valuations being very low after a major collapse (yellow arrows) and only one was a false bull market (green arrow – 1969). Besides being supported by very low starting valuations following the global financial crisis, the last yellow arrow was also supported by rand weakness.
The Alsi has gone sideways for three years. It has fluctuated between 49 000 and 55 000, and many believe we are “owed” a bull market. The argument is premised on the fact that the three-year return number is as low as it last was in the early 1980s, and after all other prolonged periods of poor returns we experienced a bull run.
If you are of this disposition (perhaps a glass-half-full type of person) you must inherently believe that one of the three things mentioned at the start of this article is about to happen.
We could get a “false” bull market. Let’s hope not as this is truly value destroying.
We have not had a major correction so current valuations are not particularly compelling. While the underlying current valuation of the market for example excluding rand hedges and Naspers can be debated, it will still be difficult to argue that the market is excessively cheap now.
Therefore, an earnings surge must be expected sometime soon. But what could drive a sharp rebound in earnings? We consider a few interdependent scenarios.
A surge in global economic growth and another China
Synchronised global growth or structural support for commodity demand has historically been a major driver of earnings growth for the Alsi, widely regarded as a resources bull market. Resources companies make up ~22% of the Index and a surge in commodity prices will be supportive of this section of the market. While all these companies do not operate in South Africa, it is still a mining country and strong commodity prices will filter through to domestic economic growth, rand strength, and perhaps lower interest rates which will perpetuate a broader economic rebound and provide support to the rest of the market.
The current global economic situation is relatively supportive of commodity prices but no great surge is anticipated. China’s growth boom was unique in that it was very commodity intensive. India may be the next China, but this is a medium-term prospect at best and will probably not be as commodity intensive as China. A rebound in Europe and anticipated infrastructure rebuild in the US could also be positive, but again no great demand surge is anticipated.
If no great demand surge is anticipated, a commodity boom is not on the cards and earnings will not increase by enough to induce a bull run.
An improvement in domestic economic growth
We expect South Africa’s economic growth to be sub-par for some time. A combination of structural weakness and political uncertainty has had a significant impact and has even hampered our ability to partake in a synchronised economic growth scenario.
Even if this was to change, the representation of the domestic economy in the All Share Index is now small (probably only around 25%) so local growth can also not drive an overall earnings surge for the Index.
Over the last few years the composition of the JSE had changed quite dramatically. Most of the large capitalisation shares are either pure global stocks (like Richemont and British American Tobacco) or are SA-based companies that have expanded quite dramatically globally (like Aspen and Naspers). For this reason, local currency movements can impact the earnings profile of the Index.
While we acknowledge that the rand remains vulnerable because of political fluidity and perhaps further credit downgrades there are still risks to the upside for the currency – portfolio flows could be supported by emerging markets generally returning to favour, and our current account deficit is improving. The reality is that it is very difficult to predict what this currency will do near term.
It is therefore tough to tell where the next bull market will come from or if it will even come. And while it is not our base case view, one thing is for certain… we are owed a bull market!
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