So it has finally happened. The inevitable pullback in the equity market, the spike in volatility, and a return of the acknowledgment of risk, followed by some strong rallies. It did not quite happen in May, as market lore would have us believe, but in July. Since then, there has been a strong recovery, followed by renewed jitters after this week's interest rate hike.
Either way, there has been enough upheaval to unsettle the strongest stomach. However, there are a few categories of investors who should not feel the need to reach for the Rennies.
Let's look at the backdrop for South African investors whose main investment consists of local equities.
Setting sentiment aside for a moment, we can crystallise the basic analysis into three parts:
- The prospect for growth;
- The valuation of the market; and
- The direction of interest rates.
Growth prospects weaken
The local and world economies continue to show positive growth, but with somewhat of a slowdown in many parts for the next year or so. This has implications for companies' ability to continue growing their earnings at the pace we saw before July. So, while earnings growth in general terms is likely to remain positive, it should take place at a slower rate.
The average price-to-earnings ratio (PE) of the South African equity market is 14 times at the moment. As always, this belies a large range of valuations, with some shares trading on historic PE multiples of 8 to 10 times. The long-term average is around 12, and 20 times would be seen as an extreme. Our market as a whole is, therefore, somewhat expensive using this measure.
It is worth pointing out that when earnings growth slows, it is uncommon to get a higher PE ratio in response. In other words, the market rewards earnings upgrades (higher growth than expected) and faster earnings growth (higher growth than before) with higher multiples and vice versa. However, investors tend to overreact at both ends, over-penalising the market on negative news and over-rewarding good news.
Many fund managers take advantage of this behaviour. Over the longer term (10 years), the buy-and-hold investor can still get an acceptable return by buying when the PE is above average, but the return when buying between a 10- and 18-times multiple tends to be lower (nine percent to 12 percent a year) than when you buy at the cheaper levels of below 10 (source: Stanlib).
Interest rate hikes are likely to have a dampening effect on growth prospects for certain companies, particularly those that operate in the consumer market.
They also have the effect of making any future stream of investment income worth less in today's terms. However, while South Africa is still on the hiking path, larger global economies are indicating that they are seeing the peak in their interest rate cycle, a move that often underpins their equity markets.
Stable global markets are generally positive for us. The United States Federal Reserve's recent cut in interest rates has certainly injected some confidence back into world markets.
Stick to the plan
So are you one of those investors who can see the current turmoil in context and stick to your original plan? If you are invested in an income-orientated fund (usually with some combination of interest income instruments, property and dividend-yielding shares) and you are only drawing the income, you can be less concerned about the daily shenanigans of the stock market.
Given the combination of higher interest rates, a good outlook for property distribution rates and continued earnings growth (providing dividends), your income stream should remain in place.
If you are in such a fund, you may have forgone some of the fantastic capital growth seen in pure property and equity funds, but your strategy will be coming into its own now.
You may want to think of this as a balancing act that is working for you, where one part of your portfolio (higher interest rates) is compensating for the other (potentially slower growth in dividends).
If you are a monthly investor and still have many years before you plan to retire, or look forward to many more years in retirement, you should appreciate the fact that you have plenty of monthly contributions ahead of you. They are probably worth more in present terms than the sum you have invested in the market.
More importantly, you are getting a chance to buy into your retirement fund at levels last seen in April. So, you may want to think of this as a seasonal markdown on something you will have use over many years. If you do not contribute monthly but have a lump sum in the market, with many years ahead of you before you retire, you have time on your side.
Visibly shaken
The wild swings that we have seen in the market on a daily basis should act as deterrent for you to try to fiddle in the short term and try to time the market.
A colleague who was in the UK recently visited fund managers there on the day when the Japanese market fell by five percent. She said the fund managers were "visibly shaken" by the event.
Even hardened investment professionals can find it tough to remain focused and calm in this environment, but an emotional response is seldom wise. If you are with a fund manager who has a cool head, you are better placed to take advantage of the shorter-term swings to reposition your portfolio.
At the risk of being dubbed a Pollyanna, it is worth reminding yourself that if you are in one of the situations described above, there is a silver lining and there is opportunity to be had in these turbulent markets.
If, however, you have been trading single stock futures on borrowed money, well ... perhaps stepping back and taking a breather until things calm down may be a good idea for you.
- Anet Ahern is the chief executive of Sanlam Multi Manager International