SIMON BROWN: I’m chatting now with Schalk Louw from PSG Wealth Old Oak, where he is a portfolio manager. Schalk, I appreciate the early morning. You put a tweet out over the weekend talking about the Cape Shiller ratio, and how it helps us understand discounts. I suppose we need to step back a moment, to help us understand what is Cape and Shiller – and what is that ratio?
SCHALK LOUW: Well first, good morning, Simon, and good morning to all the MoneywebNOW listeners. The Cape ratio has nothing to do with the Cape or the weather. Cape actually stands for cyclically adjusted PE ratio. The metric was developed by Robert Shiller and it was popular in let’s call it the late nineties, during the dot-bomb bubble era. We argue – and for that matter correctly argue – that equities were extremely overvalued. For that reason, they call it the Cape ratio or even the Shiller PE, meaning it’s basically a variant from the normal PE ratio.
Now, for those listeners out there, the PE ratio – that’s one of the most commonly used ratios to find out if equities are looking good or bad – where they basically take the earnings of a share and, well, take the share price and divide that by the earnings of the stock.
Naturally, you won’t to be buying a healthy growing company when share prices are trading at a low PE ratio. This is a problem. We’ve seen this first hand over the past let’s call it 18 months, During times like for instance now with Covid-19, or during recession times, stocks will fall but the corporate earnings will also fall very, very sharply and temporarily raise PE ratios quite high. Since we want to buy a PE ratio when it’s low, this gives a false signal that the market is actually expensive. We’ve seen this.
So what Robert Shiller has done, he basically designed a PE ratio or, like I mentioned, the cyclically adjusted PE ratio, where he takes the average of the last 10 years’ earnings adjusted for inflation and divided by the current share price, or the current index price, to give an idea of a full signal. It’s a beautiful, beautiful [method]. You don’t have to use it only on an index; you can use it on share prices. It gives you an idea of a full, full signal.
SIMON BROWN: That’s the point, as you say. It gives you sort of through the cycling, You then crunched it and you put it out on your Twitter account, which is @SchalkLouw on Twitter. You had it there and you ran through a number of countries. The two that stood out – obviously we look to our local first – and you are comparing the current Shiller Cape ratio to the 15-year average. It’s telling us that actually our market is trading at a discount to that 15-year average. That is, we are cheap.
SCHALK LOUW: Mm. We are one of a few countries running at a discount. A lot of people argue there’s a good reason for this. We know the cycle that we’ve been in. I’m not going to try and argue the fact that we’ve been in a horrible cycle. But I think when we look at specifically South Africa compared to something like a US, and that’s the point that I wanted to make, the US now is trading very, very close. Previously they were saying, “Oh, look at the PE ratios, the S&P 500 … now trading very close to a Cape ratio back on the dot-bomb era, South Africa is trading at a discount.
And I do think, when we look at the previous time where our cycle actually made this turn, it was also the start of a commodity cycle. If this commodity cycle does continue, I think that there’s some value, specifically looking at the Cape ratio value in South Africa.
SIMON BROWN: And that commodity cycle – it’s not so much the sense that commodity prices need to carry on moving higher. That would be nice. If they can just stay at these levels we’re in for a good road. We chatted before about how that benefits not just the miners, it benefits the currency – and of course National Treasury and tax receipts.
SCHALK LOUW: Undoubtedly. Just look at our gold miners. Our two largest gold miners in South Africa, Gold Fields and AngloGold mine their gold currently below $1 100 per fine ounce. Even if the gold price stays at let’s call it $1 800 – not even, you can trade below this – they are making a lot of money, not only for the mines themselves but also for South Africa in that sense.
So yes, it’s a good point to make, but looking back to the Cape ratio, I think caution when you look at companies or countries that are trading at very high Cape ratios, and maybe just start focusing on the Cape ratio, so it’s looking more attractive.
SIMON BROWN: And the US is the one at a massive premium. We’re coming into earnings season there, and we were chatting with Nick Kunze yesterday. This earnings season is expected to knock it out of the park. It needs to knock it out of the park because those valuations are stretched.
Schalk Louw, portfolio manager at PSG Wealth Old Oak, I appreciate the time.
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