ON THE face of it, the series of record highs reached by the JSE allshare index this year should be good news. However, domestic equities should be viewed with caution in light of the weak state of the real economy.
In a bumper year for investors, the 164-member all-share index has gained more than 20% to date, the most since 2009, when stocks were recovering from the aftershocks of the financial crisis. On Tuesday, the Alsi reached yet another record high, closing 0.4% higher than the previous day, at 38,535.97 points.
These figures are in stark contrast to the real economy, where mining output has plunged and retail sales figures fell in September and October. Although manufacturing data showed that production rose 1.2% in October, this followed a contraction of 2.8% the previous month. These figures were offset by a 1.7% and 0.3% dip in retail sales in October and September respectively. Even more worrying data were released earlier this week, showing that the mining sector lost 15,000 jobs in the third quarter. In September, mining output fell 7.2% compared with the corresponding period last year. These losses reflect the extent to which the slowdown in global demand for commodities, coupled with disruptive wildcat strikes, has ravaged the sector.
Given such poor domestic conditions, it is not surprising that much of the index’s strength has come on the back of foreign buying. Recession in Europe due to state-imposed austerity measures, and slow growth in the US, have resulted in investors seeking better yields in emerging markets such as SA. This is particularly in the bond market, where foreign interest has helped push portfolio flows to more than R93bn this year, compared with less than R50bn last year.
The rapid increase in bond inflows is in large part attributable to SA being included in Citigroup’s influential world government bond index in October, although strike action and increased political risk have also encouraged risk-averse investors to move into bonds.
Adverse economic conditions internationally have seen the development of a trend towards off-loading growth assets in favour of yield instruments such as bonds. Quantitative easing in the US has also benefited emerging markets as investors have sought opportunities for better returns.
The record-breaking JSE highs are also a consequence of a weak rand. So far this year, the rand has weakened by more than 6% against a trade-weighted basket of currencies. This has benefited companies that derive most of their profits in foreign currencies, and has therefore boosted rand-hedge stocks.
Although the steady climb of SA’s share prices is heartening in an otherwise pessimistic economic environment, it is questionable whether these levels can be sustained. Labour unrest and policy uncertainty, coupled with increasing corruption and ratings downgrades, have in recent months made foreign investors more negative towards SA.
Although many investors still see Africa as the next big growth opportunity, they are understandably wary about investing capital in SA. Under these conditions, they have chosen to rather keep their assets fluid to be able to exit quickly should the need arise.
It is possible that a global recovery next year could help push domestic equities even higher, but several factors suggest the risk is mainly on the downside. Although local bonds are attractive because of their higher yields, a lower growth outlook coupled with decreased foreign investment is making them look increasingly overbought. If investors suspect the government is unable to meet its obligations, a rapid sell-off is likely.
Further, as growth slowly returns to the US and Europe, foreign investors will start to move back into higher-yielding equities and safer low-yield bonds.