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Investment Strategy
Monday, November 1, 2010
Rollercoaster ride

Equity markets have had a rollercoaster ride in 2010. The All Share Index finds itself 5% up year to September, having been 7% down in February, 8% up in April and then 5% down in July. Indeed this year has seen very wild swings in investor sentiment and as a result very sharp moves on global stock indices. “Whilst global monetary conditions are as aggressively accommodative as they are - in South Africa we now have the lowest interest rates we have seen in thirty years- it is not surprising that money finds its way into risky assets such as equities,” notes Shaun le Roux of Alphen Asset Management. He was writing in the company’s Alphen Angle newsletter.

“But, as recent headlines keep reminding us, the global economy faces many challenges, not least of which is the mounting public debt burden. The investment universe remains extremely polarized and there is no shortage of commentators and asset managers who are extremely bearish. You don't have to look far to find predictions of an imminent crash on equity markets and the onset of the next global recession.
“But our assessment is that carefully selected stocks (domestic and international) will deliver more than adequate returns over the next few years in any event other than a collapse in earnings, especially when such returns are compared to those available on fixed interest markets.” Sure, equity returns on the JSE will be much lower than the experience of the previous decade, but equities are likely to remain an important asset class for beating inflation.
What is particularly noteworthy of equity performances in 2010 is just how well some shares have done. “It is worth pointing out that there is a long list of domestic industrial (and a few financial shares) that are trading at or about twelve month highs,” he notes. “The list is dominated by the retailers - where the average stock is more than 30% up this year - and includes the likes of Richemont, Old Mutual and the pharmaceutical companies.”
The graph is telling. It demonstrates the significant outperformance by the Satrix Divi ETF (a portfolio of high yielding stocks on the JSE) of the JSE All Share Index in 2010.
There are a few possible explanations for the recent outperformance by domestic plays. Firstly, interest rates have been cut by a further 100 basis points in 2010, which should be supportive of domestic consumption. Also, there has been strong demand for emerging market stocks, particularly domestic consumer stocks, with global investors much more confident on the sustainability and growth in consumption in faster growing developing economies than low growth developed nations.
Thirdly, earnings are more predictable and the range of profit outcomes is narrower for many of the higher quality domestic stocks when compared to companies that rely on global economic growth. By example, when predicting 2012 earnings, Shoprite is likely to have a much narrower range of outcomes than Anglo American.
And lastly, when after-tax cash yields are as miserly as they are at the moment, companies with relatively high dividend yields that are secure and likely to grow become increasingly attractive for investors.
“It is now our contention that many of the top-performing domestic stocks are quite expensive and we would have a strong preference for their counterparts on developed market stock exchanges. However, the search for yield is likely to continue and relatively high dividends are expected to continue to underpin the lofty share prices of some of the domestic plays.”
 

Copyright © Insurance Times and Investments® Vol:23.11 1st November, 2010
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