Wow. The FTSE/JSE All Share Index (Alsi) hit an amazing 47 000 on Wednesday. This time last year, the Alsi was at about 40 000. This makes the 17 000 to which the Alsi fell in 2008 a faded aberration.
And an aberration it was, although the fall-out from what caused the plunge – the United States-inspired subprime lending crisis – will take years to work its way out of the global economy.
For the past two years, market-watchers, portfolio managers and others have been warning that you should not expect a repeat of the returns that have been earned over the past 10 years. But the markets have proved them wrong.
Last year, when the Alsi hit the 40 000 level, I was worried that things were becoming a bit hectic.
Some wise people were saying that a shift to offshore markets was appropriate – and it certainly was appropriate, given the poor performance of the rand against other currencies and the improvement in foreign markets.
I was concerned about the JSE last year, because the Alsi’s price-to-earnings (P/E) ratio was starting to get out of hand.
To me, equity market reality is determined by whether or not the profits made by listed companies and the dividends they declare now and, potentially, into the future justify the price of their shares.
Asset managers use many methods to find value, but, to me, the best rule of thumb has always been the P/E ratio. It is the price of a share divided by the profits made by the company. The average P/E of the Alsi is 11.9, so anything above 14, and I start to worry; anything below 14, and I get excited.
In simple terms, a P/E of 14 means that, at a company’s current level of profitability, it will take 14 years to cover the cost of the share.
The average P/E at the start of bear markets when the Alsi has dropped by more than 20 percent has been 15.6.
The P/E ratio is by no means a perfect measure, but it is a good rule of thumb.
There are valid reasons you should invest in a company even when its P/E is above 14 (for example, its profits are expected to grow). Likewise, there are reasons you should not invest in a company when its P/E is below average (for example, the company’s prospects are gloomy).
And there is no guarantee that a current P/E will be the future P/E; nasty surprises can slash P/Es – for example, a global recession sparked by an incident such as the subprime mortgage meltdown of 2008. People lose their jobs in recessions, so companies sell less and therefore they make lower profits, which, in turn, may have a negative impact on the P/E, based on what you pay for the share now.
At 47 000, the Alsi has a P/E of 18.8. Should we be worried? In a way, yes, because an average means that at times there will be below-average performance.
The usual reason for a drop below an average P/E is a fall in share prices, which can be caused by a wide range of factors, including a growth in company profits.
Above-average P/Es can also be attributed to numerous factors, of which the main one is expected higher company profits.
I suspect that in South Africa the sustained upward pressure on share prices has much to do with the stream of money from retirement funds. There is more than R3 trillion in retirement savings, and a lot of this money is invested on the JSE. As long as money keeps flowing onto the JSE, it will have a positive effect on share prices.
The question is what you should do with your existing investments and where to invest new money.
Last year, you could have sold and/or invested offshore and you would have scored, although you would also have done well if you had remained where you were.
This year, things have changed, and offshore is no longer such a wonderful attraction – markets have recovered and the rand has taken a nasty hit.
I remember how, after exchange controls started to be eased in the mid-1990s and the rand was sinking – reaching R20 to the pound when it hit bottom – investors rushed offshore, mainly using high-cost life assurance products. The high costs and the recovery of the rand left many of them out of pocket.
Many investors who acted out of irrational fear also got it wrong in 2008 and 2009, when the Alsi dropped to 17 000 and they fled to cash. In fact, that was when they should have invested in equities. Investors who went into cash probably lost money, because interest rates were below inflation. Investors who fled to cash lost out when the Alsi turned around and then rose in value to, now, more than double its low.
The current situation is unpredictable. In my view, two main factors are affecting the rand:
* Locally, the uncertainty surrounding the forthcoming general election, as well as strikes and threats of strikes, with the Marikana tragedy still influencing perceptions about South African labour relations; and
* Abroad, the tapering off – particularly by the United States central bank – of economic stimulus packages. This is expected to end the record-breaking low interest rates and see investors in developed market equities earning better returns.
My view has always been that one should invest for the long term. Last year, despite my concerns about the P/E, I kept on investing, both locally and abroad. So what if share prices fall back somewhat, as they did when the bell to open the JSE sounded on Thursday. I and those who have been investing steadily over the years will still be strongly in the profit zone.
When the Alsi was at 40 000 last year, the JSE seemed expensive, and there were all those warnings that you should not expect extraordinary returns. But if you had heeded those warnings and opted for cash, where would you be today?
The average person should not try to guess where to invest. Most of us do not have the skills or the time to study the markets properly. What we should do is:
* Keep saving; and
* Use products where an asset manager makes the investment decisions on our behalf. The best products are likely to be those that combine the asset classes of cash, property, bonds and shares.
A diversified portfolio that invests in all the major asset classes both here and abroad (or separate diversified local and foreign portfolios) will remove much of the risk. Your best options are probably collective investment schemes: unit trusts and exchange traded funds.
It will be interesting to see where the Alsi is this time next year.