Investment Environment January 2018

29.01.18

The year 2017 turned out to be great for equities. As shown in the table, all markets finished 2017 with good returns (see 2017% change). The US equity markets performed extremely well with the NASDAQ (technology) leading the way with a +28.2% return. The UK lagged most markets, with the FTSE 100 providing only a +7.6% return. The JSE All Share managed a return of 17.5% in spite of the Steinhoff debacle. The JSE Resources lagged but have shown a strong start to 2018.

As we begin 2018, Investors are exercising their minds and in some cases are questioning whether valuations, particularly in the US, have been over-extended – as an example see the PE ratios in the table above. Historically there is little correlation between high PE ratios and share price performance but naturally equities are more expensive than they were a year ago. The question that should be asked is what justifies this, and some factors to consider are:

  • Interest rates (see Graph 1) have been low and we can expect increases, as broadcast by the FED, in 2018. However, it is likely that developed market interest rates will remain benign and therefore unlikely to threaten equity valuations;
  • The synchronised economic growth (see Graph 2 and 3 below) around the world remains intact and this should support equity earnings;
  • Corporate reports at the end of 2017 and into 2018 have surprised on the up side, supporting these higher valuations. Furthermore, the “Trump Tax Bill” will allow corporates to show stronger earnings net of lower tax going forward.
  • The US equity bull market is less than a year away from becoming the longest sustained bull market since 1945. The current bull market began in March 2009 and in the event of it continuing to 2019 its period will exceed all bull markets post World War 2. This is simply encouraging but who knows if this record will be achieved?

A word on the Rand

One can never be sure on currencies but it is likely that the current ZAR strength is as a result of politics, which is largely driven by Cyril Ramaphosa’s success in winning the ANC Presidency which implies that he is likely to achieve being President of South Africa in due course. Politics should not affect currencies other than the expected political influence on the economy and therefore one can conclude that the markets are forecasting Zuma’s recall and Ramaphosa’s unhindered ascendency to President of South Africa. More importantly, the currency market is assuming Ramaphosa has the ability to clean house and demonstrate that government is supportive of economic growth. This should improve business confidence and maybe allow the release of the large cash holdings on corporate balance sheets into the economy which is potentially South Africa’s major source of funding for investment. The two Zapiro cartoons below demonstrate the artist’s uncanny way of summarising the current political situation.

In conclusion, while we recognise that in 2017 the market performance stretched valuation criteria of equities, we see no fundamental reason for markets to severely correct. However, equities are always volatile and typically react to an unpredictable event extraneous to economic fundamentals. The JSE will experience pressure because of its natural bias as a ZAR hedge but time will tell as much needs to be done to turn the economic corner that is assumed in the current ZAR/USD rate.

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