It has been a very interesting year so far and it is not even June. The last year has shown great volatility in global markets with all markets still in the red, in US dollar terms, albeit after the latest three-month recovery. It is important to take a step back and have a look at what has actually happened.
One always looks at South Africa and analyses how our market is doing, but what we have seen recently is that the global economy is ever more becoming one with decisions being made in certain countries impacting other nations around the world in a good and bad way.
One of the big talking points recently is the recovery of emerging markets. So let us see how we compared to other nations who are also competing for foreign investment from the developed world.
The graph below shows the performance of various emerging market economies over the last year in US dollars.
Source: NFB Asset Management
What we can see is that most emerging markets have had it tough over the last year until around January when the Federal Reserve in the United States decided not to increase interest rates. This decision had a positive impact on emerging markets as investors decided to take on more risk and invest in riskier assets like equities and emerging market economies. This is a classic example of the risk on/ risk off trades we have seen in recent years.
Albeit that we have seen a rally over the last three months all emerging markets shown here are still negative over a one year period. Even with some recent rand strength and a market rebound we still find ourselves down 23.3% in USD. The JSE is down around 5% in rand terms.
It is important to note how our index has done in USD, in order to see the returns that foreign investors have realised over the past couple of years. The recent sudden rand depreciation has woken investors up to the fact that there is almost another “real/hard currency” return, a USD return and as we can see that most South Africans lost 23.3% of their wealth over the last year, if they were solely invested in rands.
When we turn our attention to global markets and again compare the JSE to global indices, we see that only the S&P 500 is close to its original level from a year ago. The graph below shows that these major indices in USD are negative over the last year. We can also see that all of them, with the exception of the Hang Seng index in Hong Kong have performed better than the JSE.
Source: NFB Asset Management
The reason for the rebound may have been that valuations have looked a little better for investors, as well as continued accommodative monetary policy globally. Europe is committed to large-scale quantitative easing programme, including buying corporate bonds and effectively having a negative lending rate. Japan still printing money more aggressively relative to the US and the one that impacts markets the most is Janet Yellen and the dovish tone from the Fed in announcing that they will keep interest rates at the current levels and so indicating a slower rate of increase. All this is good for growth assets like equities.
One then has to ask, with a global economy stumbling along in a low inflationary, low growth and earnings environment, what can investors expect from global equities. The charts above potentially say that there may be value still on offer when comparing where indices are from a year ago. However, when one looks at the Price Earnings (PE) multiple it may tell a different story. The PE gives guidance as to how expensive a market is and when we compare the current PE to its historic average it gives an indication if the market is relatively expensive or cheap.
The graph below shows the current PE compared to its historically average for a select number of global markets.
Source: NFB Asset Management
What is interesting is that we can see all major indices displayed are above their long-term averages, which implies that they are currently expensive.
By the principal of mean reversion, the current value should oscillate around the long-term average and if this is the case then we should expect PE ratios to decrease. In order for this to decrease one of two things has to happen.
- Firstly, company earnings need to increase with share prices remaining constant, which would bring it back in line with the average. As discussed above with world economy expected to growth at a slow rate one might argue that this may not be the driver.
- The second way is for there to be a share price correction and so reducing the ratio, bringing it back into line with its historical average.
This is in no way a suggestion that there is a potential pullback coming down the line, but what is most likely is a combination of muted growth in earnings and pedestrian growth in equity prices. One thing that is certain is that volatility is probably going to be par for the course.
This analysis is at a macro level and if we allow ourselves to dig a little deeper we can see that a dispersion in various markets exists, both in sectors and specific counters, which shows us that opportunities are there, they are just a little harder to find. What we can see from our market is that year to date the resource index is up 19%, financials down 2.6% and industrials 2.7% with the JSE being 2.3% up year to date. This is in stark contrast to recent years where resources have been under immense pressure whilst financials and industrials have thrived.
What we can take out from this is that we are likely to see muted returns in the short term, with continued volatility. More importantly one needs to be globally focused in order to find various investment opportunities that maybe out there and cognisant of a global return.