There is significant evidence to suggest that the SA equity market is expensive, more expensive than it’s ever been in the post-apartheid era. With stock prices at elevated levels and price/earnings (P/E) ratios for some companies looking excessively high, one might be inclined to sell out of SA equities and buy into the safety of cash or other alternative assets.
Tthe current P/E ratio is at a 20 times multiple. However, when dissecting the market into basic components such as resources, financials and industrials, one is able to see that the current rating of the market is distorted by significantly overpriced rand-hedge industrial companies.
If you exclude companies such as Naspers, British American Tobacco, SABMiller, Richemont, Remgro and MTN, the P/E ratio drops from a high of 20 times down to 11.5 times (including earnings projected one year forward). But the major reason why investors should maintain their exposure to SA equities is primarily due to the fact that, over time, the market rewards those who stay invested, in both good times and bad.
Looking at the 50 worst drawdowns experienced in South Africa since 1928, it is noticeable that most of the drawdowns were followed by 12 months of recovery, rewarding investors for staying invested.
The average size of the drawdowns experienced over these 50 periods was 16.5% and took just under eight months to transpire. Had you stayed invested for the next 12 months, you would have received an average return of 25.8%, which is better than the breakeven required of 23.7% (the return required to recover the 16.5% drawdown). The market expected this recovery to occur over two years, but it actually happened in less than nine months on average. In essence, had you remained invested, your portfolio would have been worth much more.
The evidence presented should not detract from the fact that, collectively, the market is currently expensive. The information above concludes that there are certain areas of the South African equity market that are expensive and others that present opportunities with some attractive valuations. What it also shows is that market volatility and drawdowns, much like the one we are currently experiencing, have occurred many times in the course of history.
With the negative sentiment towards risky assets such as equities, both locally and globally, it may be tempting to become risk averse and switch out of equities and into lower risk asset classes such as cash. However, time has shown that investors are better off resisting the temptation to sell out of their long-term plan, and not reacting to short-term market movements.
If you stay invested over the long term, on average, the outcome is usually better than the market losses experienced in the short term. The skill is to ensure that you have the correct underlying strategies to navigate this volatility over the long term and to stay the course. At Sanlam Multi Managers, we are constantly reviewing our investment strategy and the asset managers whom we appoint. It is important that the underlying funds will first and foremost assist in meeting the objectives of our clients (with acceptable risk tolerance) and help navigate the current and ensuing market conditions over the long term.
By Rafiq Taylor, portfolio manager at Sanlam Multi Managers