Irrational exuberance – Greenspan’s term aptly describes JSE heavyweights circa 2013

There's much to be said for personal experience. My first stock market bubble was in 1987. Things were so crazy back then that my employer, Prescon, ran a daily share tipping service. Punters would phone an answering machine which would play my recorded "tip" of the day. They paid the equivalent of R8 000 a month for this dubious privilege. There were hundreds of them. Even to someone in his 20s this seemed out of whack. I'd read books about the US's Roaring Twenties and the similarities to Joburg in 1987 were stark.

Looking back, I recall two things most clearly about that insane period. First was the inimitable Donald Gordon floating the largest right issue the market had ever seen concluded a few weeks before the Crash. He saw it coming. The other was a Sanlam investment report arguing that inflation adjusted, the JSE was still a long way behind where the bubble of 1969. They, amd many other pundits, just weren't prepared to see the inevitable which happened on October 1987's Black Monday when prices crashes over 20% and dropped to half their previous levels before their slow recovery. – AH

By Alec Hogg*

On December 6, 1996, then-US Fed chairman Alan Greenspan suggested in an otherwise typically dry speech that asset prices had been inflated by "irrational exuberance".

Within months stock markets around the world had taken a tumble. Greenspan's warning was universally applauded. His the term stuck.

In 2005, Yale University professor Robert Shiller updated his book using the term as its title. Shiller's Irrational Exuberance forecast the imminent burst of the US's Housing Bubble. When it duly happened, the term was further elevated to a permanent place in the investment lexicon.

But knowing what's happening and actually doing something about it are never the same. Much as we may feel irrational exuberance spreading, memories are short. Besides, there's always a younger generation to explain why this time it's different.

So history keeps repeating itself.

The mining industry, caught up for the past decade in the China Growth story, provides a contemporary example.

This time, the fault is not with the analysis. The China Growth story has actually delivered. Demand for commodities continues to rise as the Middle Kingdom's economy steams ahead.

The problem lies, rather, with a mining industry so irrationally exuberant its managers miscalculated the impact all this new supply would have on prices. So just as new projects began producing, the commodity market reversed into a softer trend that could continue for years.

So the recently buoyant industry is now being squeezed in a vice that makes it damned if you do, damned if you don't.

During the seven fat years from 2005, miners generated $126bn in earnings, much of the temporary "super profit" variety. But they foolishly spent almost three times as much – $348bn – on new capex projects to replenish depleting reserves.

According to research shared at Glencore's recent Investor Day, in their haste to get product to market, miners swallowed project cost overruns averaging 35%. That, together with sliding commodity prices, has wreaked havoc on their feasibility spreadsheets.

Worse still, now that the economics have changed, there's no way of simply turning off the tap.

Mining projects are lengthy events. Once pregnant, the investing company is pretty much forced to throw good money after bad. Shareholders are furious. Little wonder over half those who ran mining businesses at the start of the boom no longer occupy the corner offices.

The trick, obviously, is to identify irrational exuberance when everyone else has the fever. In this regard, research by Cannon Asset Management could prove as prescient as Greenspan and Shiller.

Adrian Saville's team has unpacked the underlying reasons for the South African stock market's recent surge. They discovered three heavyweight stocks accounted for over a quarter of the JSE All Share Index's 27% jump in the past year. Remove SAB Miller, Richemont and Naspers and the ALSI's improvement drops to 18%. Eliminate eight more counters and the "overall" return is down to single digits.

SABMiller's share price is up 36% in the past year. Richemont has risen 78%. Naspers 86%. Yet money managers keep putting their clients' savings into these obvious momentum plays. Hoping when the time comes, they'll beat the crowd to the exit.

Saville worries about valuations when the market cap of a business gets to 10 times mid-line profit. At 15 times he runs for the hills.

The three stocks that have generated so much of the JSE's recent heat are now well over 20 times. As are virtually all of the JSE's Top 20. Only two of these heavyweight counters, Sasol and Reinet, currently trade below their intrinsic value.

You've been warned.

* Alec Hogg is a writer and broadcaster. He founded Moneyweb and now runs biznewz.biz. This column, Rational Alternative, appears first in the Financial Mail every week.