Barely a day goes by these days without an investment expert pondering whether the only way for the JSE FTSE All Share Index from here is down. Geoff Blount, CEO of Cannon Asset Managers, says his team has almost no exposure to South African large-cap industrial shares because they are incredibly expensive compared to other stock market investment opportunities. He says: “If local large-cap industrial stocks were a standalone market, it would be the most expensive “market” in the world.”
Don’t let these numbers put you off investing in Johannesburg-listed shares, though. As Geoff points out, there are good opportunities to be found in other sectors. His team has been looking at financials, small caps and resources companies, as he explains in this piece. – JC
By Geoff Blount
Geoff Blount, CEO of Cannon Asset Managers, explains the different valuations of SA’s super sectors and cautions on where to invest*
With the JSE FTSE All Share Index hovering near record levels, investors may be wondering whether this is an appropriate time sell local shares and invest the proceeds overseas. But valuations vary widely on the domestic market and we need to look more deeply at what is driving the JSE to answer the questions. Figure 1 is a really neat way of highlighting the conundrum South African investors face.
It shows the current Cyclically Adjusted Price Earnings (CAPE) ratios for various countries (the red dots) versus our local super sector CAPEs (the green dots). The vertical line is the historic range of CAPEs for that country or super sector, so the chart also shows its valuations relative to its own history. As a reminder, CAPEs are a great way of assessing the relative value (expensiveness or cheapness) of an equity market. It is the price of the market over through-the-cycle or “DNA” earnings of the market, as opposed to the traditionally used 1-year Price Earnings (PE) ratio that shows how much you are paying for just last year’s earnings.
Figure 1: Current CAPE ratios around the world versus South Africa’s super sectors
This chart is one that professional investors drool over, as it presents a huge amount of very useful information in an easy to understand format. However, given that our market is expensive versus the rest of the world, the conundrum it presents for SA investors is: should they sell local equities to buy offshore equities at this stage?
By way of explanation:
- The South African CAPE sits at the midpoint of its historical range BUT is among the 25% most expensive global markets. In other words, we are fairly valued relative to our own history, but expensive when compared to most offshore markets.
- This would infer that local investors should diversify overseas given better valuation opportunities offshore. This is reinforced by our view that your decision to invest offshore should be governed by the valuation of the investment opportunity you can buy, rather than on a prediction of what the rand may do.
- Also interesting is that most countries are not only cheaper than South Africa, but also near the bottom of their historical valuation ranges, with the US as a notable exception.
- It also highlights that most of Europe is on very attractive ratings and currently presenting some interesting opportunities for investors.
But, before you rush to sell all your local stocks to buy offshore equities, what does the analysis tell us about our own market?
- SA’s overall rating masks what is going within the different sectors.
- If local large-cap industrial stocks were a standalone market, it would not only be the most expensive “market” in the world, but also the most expensive it has ever been relative to its own history, which represents high investment risk. Cannon Asset Managers has almost no exposure to this sector of the JSE, despite it being a market darling over the last few years. If you own any of these stocks, then they would be the logical shares to sell in order to fund buying cheaper offshore equities.
- Our financial sector looks fairly valued, mid- and small-cap SA industrial stocks are attractive (not shown) and our resources sector looks particularly interesting. Resource shares are on low valuations because of the well-documented headwinds this sector faces, but the negativity towards the sector seems overdone and there are some very attractive opportunities to be found on a case-by-case basis.
- In fact, valuation dispersions (difference between expensive and cheap stocks) on the JSE are the largest they have been since the financial stock bubble of 1997 and 1998, which we know ended in tears for financial stocks.
So, not only has the market’s infatuation with local large-cap industrials created opportunities everywhere else on the JSE for astute investors, but it has also made our market expensive in a global context.
*Geoff Blount, CEO of Cannon Asset Managers
