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    Value and growth indices

    Over the years, the JSE in conjunction with the FTSE has launched many variations of indices. More and more the construction of additional indices is demand driven, especially where investment products can be created from these indices.

    The FTSE website boasts that it now calculates over 120 000 end of day and real time indices covering more than 80 countries and all major asset classes.

    In additional to the various sector indices that the JSE calculates, it has been calculating 2 style indices from August 2004.

    These are the FTSE/JSE Value index and Growth index. The value is designed to reflect portfolios focusing on the price and value characteristics of securities, weighted towards those companies with identifiable value characteristics.

    The FTSE/Growth index is designed to reflect portfolios focusing on earnings and revenue growth, weighted towards those companies with identifiable growth characteristics.

    The underlying constituents of these 2 indices will mirror the FTSE/JSE All Share index, but through the use of accounting data which is reviewed twice a year, shares are ranked. Those showing high value characteristics are classified into the value index and those high growth characteristics into the growth index. Companies that sit in the middle 30% - i.e. between value and growth – will be weighted to one of the 2 indices in a predetermined way.

    Some of the measures used in the calculation of these indices are as follows:

    Value Measures

    • Book to Price. The ratio of equity to market capitalisation. A value share wants a higher ratio.

    • Sales to Price – the most recent annual sales to the company’s market capitalisation.

    • Dividend Yield reflects the dividend declared per share as a percentage of the share price. Again a higher percentage is an indication of value.

    • Cash Flow to Price is a company’s most recent cash flow for the year divided by the market capitalisation of the company.

    The chart below reflects the JSE All Share total return measured against the value and the growth index. JSE in green, value in red and growth in yellow.

    Source: Sharenet and Market Tracker

    Over the last 2 year period, value has outperformed the JSE All Share and also the growth index.

    There is a high degree of evidence that when it comes to investing, value metrics consistently applied will produce superior performance.

    Have a great weekend


    Ian de Lange
    021 9144 966

    Permalink2010-02-26, 17:10:47, by ian Email , Leave a comment

    Global update

    The US consumer confidence index rose in January by 2,3 points to 55,9, its highest level in nearly a year and a half, but in February this has promptly fallen back by 10,5 points to 46. This is the biggest decline since last February and the general consensus was for a gain.

    Source :Wells Fargo Securities

    Yesterday, house sale stats from the US reflected a plunge in new single family homes sales of 11,2% month on month to a record low annualised 309 000. This follows an upward revised 3,9% decline in December and so this fresh data correlates with the lower consumer confidence.

    US real GDP for quarter 4 of 2009 came in at a quarter on quarter annualised 5,7%.

    GDP in the Eurozone came in at 0,4% in quarter 3 and 0,1% in quarter 4.

    GDP numbers in the UK came in at 0,1% for quarter 4. The consensus indicates that this will be revised slightly upwards to 0,2% on Friday 26th.

    Japan’s GDP, like the US, rebounded at a strong 4.6% annualized for quarter 4.

    A report from Standard Bank noted this on the UK and Eurozone GDP, “….we see a considerable risk of negative growth in Q1 after the ‘recovery’ we saw late last year. The market is perhaps not fully priced for this outcome and hence the weak pound and the weak euro can get weaker….”

    The recent turmoil in Greece has given investors a foretaste of potentially bigger problems around the world, with the developed markets operating on large fiscal deficits and ballooning government debt.

    Technical offshore markets

    There is a lot of flip flopping in global markets at present as the conflicting data is processed.

    Investors are trying to determine the sustainability of a global recovery and more importantly how much is already priced into the market. At this stage it is not that apparent that after the strong uptick in global prices that there will be a strong continuation in the shorter term.

    Source: Sharenet and Market Tracker

    Global markets have had a very strong 11 months, but are showing some signs of being unable to continue with their gains.

    The JP Morgan technical analysis is looking for the MSCI World index to move from its current level of 1129 to break through the 1200 level, confirming the upward move – however at the moment they view this as unlikely.

    The chart below reflects the 4 major global indices, the UK’s FTSE100 index, the US’s S&P500, Germany’s DAX and Japan’s Nikkei index, over a 5 year period from a common starting point.

    Source : Sharenet and Market Tracker

    While equity markets have gone sideways for 5 years and longer; depending on which market, relative to cash and bonds they are more attractive taking a 5 to 10 year view.

    According to some value manager reports, there is also a growing dispersion in valuations between the more expensive cyclical shares on the one hand and the global consumer staples and high quality companies on the other, that still have good value relative to 10 year bond yields.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-25, 16:41:56, by ian Email , Leave a comment

    Inflation and electricity hikes

    Inflation numbers for January reflect a slightly lower year on year increase. Going forward the electricity hikes over the next 3 years will prove to be a huge headwind, especially where these costs are passed through to consumers. The January inflation number came in at 6,2% year on year, down ever so slightly from December’s 6,3% year on year official inflation.

    The National Energy Regulator of South Africa (Nersa) who has been deliberating on Eskom’s proposed 3 year price hikes on electricity for some time, came out with an agreed rate hike more in line with the consensus.

    The initial application in September last year from Eskom was 45% per annum and in November this was revised to 35% per annum over the next 3 years.

    After considering all submissions, oral and written, facts and evidence provided, Nersa approved a 24,8% price hike from 1 April this year, 25,8% in 2011 and 25,9% in 2012. These percentages are on the average standard tariff.

    Nedbank’s unit believe that this hike will add 0,45% to inflation, which is lower than the possible 0,65% had the rate hike been agreed at 35%.

    Inflation for February should come in below the 6% upper limit, with the consensus expecting around 5,5%.

    Source : Nedbank Economic unit

    According to Nedbank, the year on year hike in electricity and other fuels as a line item of the total inflation data, over the last 12 months was 23,9%, while the average year on year over the past 3 years for this category coming in at 20,88%.

    The local equity market fell back slightly on the day.

    The rand was weaker against the dollar – last trading at R7,75/dollar.

    Bonds were firmer with the yield on the R157 trading at 8,26%

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-24, 18:09:19, by ian Email , Leave a comment

    Company Results

    Many companies are now reporting their results to the end of 31 December 2009. Remember that listed companies need to report results twice a year and have 3 months from period end to report their result.

    Platinum company Northam released interim results this morning which made for interesting reading. Sales revenue edged up by 7.7% compared to the 6 months ending 31 December 2008, but earnings dropped by 42%. This divergence between the top line and the bottom line can be attributed to a drop of 21% in the rand price of their average basket (mainly platinum) of goods and cost pressures mainly as a result of labour costs increasing.

    The drop off in earnings to R215.6 million saw the interim dividend declared dropping from 38c to 20c a share. The company has historically been a good dividend payer so the drop in dividend won’t be welcomed, but we must bare in mind the tough economic climate we’re currently operating in. Cash flow was positive, with a net inflow of R 54 million.

    The share price was down around 2% for the day at R47.50.

    Food retailed Shoprite also announced unaudited interims today. This company is one company that has been able to continue to grow despite the recession as a result of them typically servicing the lower end of the market. In tough times consumers trade down and this boosts lower cost retailers’ market share. Conversely in times when economies are strong consumers will trade up again negatively impacting low price retailers’ market share.

    Trading profit for the period was up 17.5% on the back of an increase of 11.9% in turnover and a trading margin that grew from 4.8% to 5% as a result of improved efficiencies. Growth in turnover slowed compared to the prior year mainly due to a moderation of food price inflation over the period. The company was able to declare a dividend of 80c a share, up 14.3%. This company has undoubtedly performed well for many years, but faces some headwinds including:
    • Lower food inflation which impacts lower cost retailers more than value add retailers
    • Consumers looking to trade up as economic growth re-emerges

    Shoprite’s share price was down around 1% for the day.

    Other companies reporting results and approximate share movement for the day:
    • Mondi up 4.4%
    • Brimstone up 5.6%
    • WBHO up 2%

    Take care,

    Mike Browne
    021 9144 966

    Permalink2010-02-23, 17:05:48, by Mike Email , Leave a comment

    Building and construction sector

    There are some mixed reports coming out of the building and construction sector. Some areas continue to do well with order books high and margins still expanding, while other sectors of this large industry reflecting a slowdown.

    Dawn is in the building and construction materials sector of the JSE, manufacturing and distributing sanitary ware, plumbing, kitchen engineering etc with brands cobra, Incledon, Isca, Vaal, etc.

    The company came out with a trading statement saying that its earnings and headline earnings for the 6 months ended December will be 60% to 70% lower than reported for the comparative period. They say that although there was improvement in the building refurbishment and upgrade sector, results were significantly impacted by delays and non awarding of infrastructure tenders.

    The price fell 2% to 720c in thin trading. It has traded essentially flat since October 2009.

    Another company in a similar industry – listed in the Construction and materials division – Aveng – advised that its headline earnings for the 6 months to December will be lower by between 30% and 35%.

    Two of the main businesses are Trident Steel and Grinaker LTA

    The manufacturing and processing businesses of the group are under pressure due to reduced steel prices and lower prices for steel and as some of the major infrastructure projects reach completion.

    At the same time the construction division has lifted contribution “with a much improved operating performance from the South African business units.”

    The share price gained 2% on the day to 3817c and a market cap of R15,1 billion.

    Other companies in this division include :

    Basil Read – down 2,9% to R13

    Group 5 - flat at R32

    Murray and Roberts up 1,7% to R40,20

    WBHO up 40c to R101,40.

    Construction share prices remain depressed compared to their market peaks 2 ½ years ago. On a forward looking basis assuming that construction companies continue with relatively high project pipelines, their valuations don’t appear too demanding, especially on a relative basis.

    The chart below indicates SA companies forward PE ration versus similar companies in the emerging markets and reflects that South Africa trades at a discount.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-22, 18:18:58, by ian Email , Leave a comment

    Correlations and bond yields

    Anglo American released its annual results to December. Revenue declined 25% with operating profit down 50% to $4,9 billion. Basic EPS fell 53% from $4,34 to $2,02 a share. The dividend was not resumed, but the indication is that this should commence again next year.

    Anglo has a market cap of just on R400 billion and is 12,1% of the Top 40 index.

    It is also one of the top 20 companies by market capitalisation on the UK’s FTSE100 index.

    The SA and UK indices have other common listings included in their respective indices, including BHP Billiton, SAB Miller, Liberty International, and Old Mutual.

    It is also very evident that over periods of time, the local JSE equity market has a high correlation with a developed market such as the UK’s FTSE100 index.

    The graph below reflects a common starting point for the JSE All Share index in green and the FTSE10 index in red in February 2008. It is evident how closely these 2 indices have tracked one another over this time period.

    Source : Sharenet, Market Tracker

    The Budget and Local Bonds

    The budgeted deficit for the 2009/10 year was set last year at R93,9 billion. The release of the numbers yesterday is estimating this at R177,8 billion – i.e. almost double the originally envisaged deficit.

    The outlook for the 2010/11, which starts on 1 April 2010 and the years following has deteriorated significantly from the previous year. The effect is sizable budget deficits compared to the numbers set a year back.

    For the current budget to 2010/11 a deficit of R168,6 billion is on the cards – some 6,2% of GDP.

    These are large numbers that the government must finance – they do this by issuing bonds in their weekly auctions. This large pickup in issuance has been widely anticipated by bond investors.

    It is therefore interesting to note that the expected increase in government debt has not put any real pressure on yields – in fact the exact opposite.

    The yield on the long term R186 reached its lowest level for the year on the day of the budget at 8,955%.

    The chart below reflects the 6 month yields of the R186 (long term) and the R157 (medium term)

    It is evident that yields have declined from mid January – i.e. prices are up.

    Source : Sharenet, Market Tracker

    After the 2009 return where the bond index returned a negative 1%, so far this year the All bond index is up 1,12%.

    Have a fantastic weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-19, 18:20:47, by ian Email , Leave a comment

    Budget Speech Wrap Up

    Yesterday was the first time in around a decade and a half that South Africans didn’t hear Trevor Manuel deliver the national Budget Speech. Pravin Gordhan has become the finance minister, after successfully running SARS, at a very difficult time. The “go go” years that we experienced in the middle of the first decade of this century are gone and Treasury is faced with a tough battle of declining revenue and growth. Borrowing requirements have sky-rocketed and they will do well to prevent the deficit from getting out of control in the coming years.

    Every year much fanfare is made at the changes to tax brackets, tax rates, and the like. While the nominal numbers grab the lion’s share of the media attention, much of the change is typically just adjusting for inflation. There will generally be some changes that are above inflation, and some that are below inflation.

    First off there was no change in the marginal tax rates for individuals. There was speculation that the marginal rate, particularly for the top bracket (40%), would increase in line with other countries, but this wasn’t the case. The Minister indicated that they would rather improve income tax receipts by broadening the tax base further and closing loopholes than increase the marginal rate, which penalises those compliant tax payers. Income tax brackets got adjusted upwards, but all bands were adjusted by less than inflation. This means that employees who receive an increase in line with inflation will pay a greater portion of their income in tax.

    The amount of interest income that is exempt from tax grew by 6.2% from R 21 000 to R 22 300 which is less than the current 6.3% inflation rate. While the amount exempted from tax grew by less than inflation, the effective amount that you can have invested in money market investments without being taxed grew by around 84% from R 190 000 to R 350 000. There has been a large increase as a result of the sharp fall in interest rates. These amounts have been calculated assuming an interest rate of 11% last year compared to 6.35% this year.

    Of much joy to many individuals was the suggestion that there might be the abolishment of estate duty in the future. The rationale behind this thinking is that estate duty doesn’t bring in much (relatively) revenue and that the truly wealthy individuals have legal structures, like trusts, to circumnavigate this tax.

    Exchange controls for individuals remain as is for now, but Treasury continues to work on the reform on exchange control regulations. The change in the way that dividends are treated (i.e. taxed in the hands of the investor as opposed to the company) is nearly complete with a few minor issues to sort out before it can be properly implemented.

    Most consumers of ‘sin products’ – tobacco and alcohol – will have to pay more for their ‘sin’ as a result of above inflation increases in the taxes on these products. Government claims that this is a result of trying to improve the health of the population, and while there is some merit in the argument, it’s most likely because these are easy areas to target. Traditional beer taxes weren’t increased.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2010-02-18, 17:00:11, by Mike Email , Leave a comment

    Global economics

    On a monthly basis, all governments measure the quantum of inflows into and from their country.

    Global investors watch these numbers closely to try and gain a sense of where the money is flowing, because over shorter periods of time money flows move prices.

    Last week we discussed the recent appreciation in the US dollar relative to the Euro.

    Statistics out this week from the US, in their TIC report – treasury international capital report, indicates that foreigners continue to be net purchasers of US securities.

    The TIC report measures the US financial account - it is of great importance in demonstrating the flow of foreign capital into the US which is used by the private sector for investments, and by the government for borrowing and spending on its various government programs.

    Source: wells Fargo Securities

    In November foreigners bought $126 billion worth of securities and in December this came in at $63 billion.

    The graph above indicates that on a 12 month moving average basis, the decline from 2007 started to reverse in mid 2009, but still only at 50% of its peak inflows.

    Commodity prices

    Commodity prices in general have moved up sharply over the last year from lows. Copper has doubled in price; oil is up 63% and platinum 41%.

    Over the last 6 months the gains have been more muted, but nevertheless in an upward direction.

    The chart below bases selected commodities to 100, 6 months back.

    Over this time period, platinum is up 25% and gold around 17%, with nickel, oil and copper up around 10%.

    Source: Sharenet and Market Tracker

    When demand is increasing, competition for scarce resources causes prices to rise. Demand will increase when consumer sentiment is high and vice-versa.

    What creates demand for commodities? Demand for finished goods.

    China is the biggest consumer of commodities. While authorities are trying to slow the economy, forecasts indicate that another 10% GDP growth for 2010 is quite possible. The CEO of BHP Billiton in their interim results said that commodity markets would be largely dependent on Chinese and Indian demand, but that monetary tightening in China would have an impact.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-17, 17:36:46, by ian Email , Leave a comment

    Absa results

    Absa results came through today for the year ended December. As expected profits were down on the 2008 year. Headline EPS fell 25,5% to 1099c, while earnings per share declined 37,5% to 986c. The dividend cover remained intact at 2,5 times, leaving the dividend down from 595c to 445c a share.

    Absa had provided a trading update at the beginning of December where it said that headline earnings were expected to be 25% to 35% lower than the previous financial year. The market was warned about the higher impairment charge due mostly to the single stock trading defaults that Absa was exposed to.

    Headline earnings fell 24% to R7,6 billion and attributable earnings 36% to R6,8 billion.

    Top line income remained essentially flat at R41 billion, as did operating expenses at R21,8 billion, but the credit impairment charge was hiked 54% to almost R9 billion from R5,8 billion.

    The company presented a graphic which reconciled the 2008 earnings of R10,6 billion to the R6,8 billion in 2009.

    Underlying growth for the year of 11% was more than negated by:

    21% decline due to credit impairments
    15% decline due to write down in private equity
    11% decline due to write down in single stock futures

    Source: Absa

    At the same time parent company, Barclays reported its annual results in the UK. These were in stark contrast. In 2008 profit came in at £6.08bn. This was almost doubled in 2009 to £11,64bn in annual pre tax profit.

    According to the FT the profit for 2009 was boosted by the sale of its asset management business, Barclays Global Investors to Blackrock in December.

    The share price for Absa closed unchanged at R133. The price is up 3,5% for the year to date against a market that is down some 3,5%

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-16, 17:54:35, by ian Email , Leave a comment

    China slows its lending

    China’s central bank, the Peoples Bank of China last week announced a lifting of reserve requirements for its banks in an ongoing attempt to try and slow down bank lending, which has been extended at a furious pace.

    One report indicated that new loans in January alone came in at 1.39 trillion yuan ($203,6 billion) with the number of new loans made in the month exceeding all loans made in the last quarter of 2009.

    The government target for the full year is new loans of 7,5 trillion yuan and so in one month alone nearly 20% has been extended.

    This follows the 9,59 trillion yuan lent in 2009.

    Money is being lent into two main areas – the housing market and manufacturing capacity.

    In addition to the raising of banks reserve requirements – which slows down ability of banks lending – the central bank has also raised interest rates by two 0,5% hikes.

    A Standard Bank forex report asks the question whether an appreciation in the Chinese currency will also serve as a moderating factor in addition to tighter monetary policy.

    The Chinese yuan relative to the US dollar has been in a tight band for the last 20 months – see the attached graph.

    They are not convinced, believing that should investors and speculators start to anticipate that Chinese authorities let their currency appreciate, it will encourage more speculative inflows into the country. The forward market for the currency is currently priced at less than a 1% appreciation versus the US dollar. The tight correlation to the US dollar is likely to persist for a while.

    Despite this cooling down of the economy, Goldman Sachs are reportedly still looking for an annual growth rate of over 11% for the Chinese economy in 2010.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-15, 17:30:51, by ian Email , Leave a comment

    Prospective property returns

    We looked at historical returns from local listed property and also the typical methodology of assessing the required rate of return. Here we consider the likely range of returns than an investor may achieve through an investment into listed property.

    The total return from listed property – as with most, but not all investments – is made up of a combination of the yield and capital growth over time.

    Traditionally property has been a fantastic investment because the largest component of the total return has been the steadier annual yield. Over the last 10 years however, except for 2008, the capital growth component proved to be a very attractive component to the aggregate return achieved.

    Because property rental income is contractually based on 3,5,10 year type leases, there is a high degree of sustainability of the income into the foreseeable future. An investor therefore buying an asset yielding say a net 8,5%, has a high degree of comfort that this yield will be sustained into the future.

    In South Africa leases have typically escalated at 7-9% per annum. As a percentage of a landlord’s leases expire, so new leases are being entered into. Expired leases ending after their typical period of on average 5 years may end, at, below or above the current market rates. Given the steepness of actual rentals in general from 2005/2006, many expiring 5 year leases are ending at below current levels, which gives landlords some margin of cushion when negotiating new leases, in a market that is seeing rising vacancies.

    The current average yield across all listed properties is just over 8,5%. An investor should receive this into the future. The next question is at what growth rates can property companies grow their net incomes into the future.

    Remember that if the required hurdle rate for property is 14%, then an investor will be looking for a perpetuity growth rate of 5,5% (income of 8.5% plus growth of 5,5%, to give the minimum of 14%)

    At face value, this does appear feasible, but opinions on this do vary. One property fund manager believes that income growth over the next 5 years will approximate 8% per annum, but slow thereafter to 4,7%. Another believes that growth income will come in at 8% over the next 12 months, but thereafter will start to slow. The more pessimistic fund manager says that over an extended period of time, the growth in income for property funds should come in just lower than the inflation rate. If investors are projecting an inflation rate of 5-6% then this is the growth rates that property companies should be producing.

    Aggregating a starting yield of 8,5% and growth rate in net incomes of 5-6% brings us back to the required 14% nominal return. I think if investors can achieve this type of nominal return, most will be very satisfied. The big question is how will growth rates moderate in this current environment of rising vacancies and higher costs. We will be watching reports from listed property companies over the months.

    Have a fantastic weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-12, 17:34:04, by ian Email , Leave a comment

    Trading Statements

    Many companies have started to release trading statements for the period ended 31 December 2009. One of the JSE’s listing requirements is that companies must publish a trading statement as soon as they are reasonably certain that financial results are more than 20% different from the previous year. While the requirement is only in place for changes above 20% or below -20% many companies these days often guide the market by announcing expected earnings growth/contraction even if it falls within the 20% range.

    Despite the pull back that the market has experienced year to date, it is still up significantly since its lows reached in early March 2009. As we mentioned last week, markets are generally forward looking, and it should therefore be no surprise that many companies are coming out with positive trading updates.

    The strength and sustainability of company earnings will determine how long and hard the market runs. The two charts below show how earnings have come off in the last year and a half or so. It looks like earnings might finally have troughed, but this will only be apparent in a few months time.

    Earnings level

    Rolling 12 month earnings growth (%)

    Source: Investec

    The market valuation is currently near the top end of its historic range and for this to normalise we either need to see strong earnings growth or for prices to come off some more. A third option would be for earnings to normalise more slowly with the market trading in a range.

    Recent company trading updates:
    • WBHO: Earnings per share growth of 15% - 20%
    • Bidvest: Headline earnings per share growth of 8% - 10%
    • Discovery: Headline earnings per share growth of 45% - 55%
    • Sanlam: Headline earnings per share growth of 60% - 70%
    • Santam: Headline earnings per share growth of 45% - 60%

    Take care,

    Mike Browne
    021 9144 966

    Permalink2010-02-11, 17:24:32, by Mike Email , Leave a comment

    required rate of return from listed property

    What type of return should an investor expect from listed property? From the article earlier in the week, we saw how local listed property has been the best asset class performer over the last 20, 10, and 5 years. Before an investor attempts to assess what the prospective return will be over the next 3 years or so, they should first try and establish the required rate of return from this asset class.

    Because investing involves taking on risk, an investor must first establish what his required rate of return is, based on assessment of the risks involved. Only then where prospective returns meet or exceed this minimum hurdle, would the investment become attractive.

    Some managers have a long running strategic required rate of return per asset class against which they measure prospective returns. Others will constantly readjust their required rate of return across the asset classes, by setting risk premiums over bond yields.

    Let’s look at the typical long run required rate of return across 4 asset classes. It may look something like this in real terms:

    Investors will demand a lower return from cash, because historically this is what it has produced and given its lower risk characteristics.

    At the same given, given the higher historical real return from equities, and the far higher risk, defined in terms of volatility and risk of capital loss, investors will demand a 7,5% to 8% real rate.

    Property would demand a higher rate of return than cash and bonds, but lower than equities. Many investment managers have set a real return of approximately 6,75%. If one adds a long term expected inflation of say 5,5% or 6% then the required nominal return is in the order of 12,75%

    Looking at the required nominal hurdle rate in a different way. In nominal terms, a required rate of return can be set as follows:

    The All Bond 10 year yield is currently at 9,1%. Add to this a risk premium because listed property is higher risk than a loan to the government. There is some subjectivity to how much this risk premium should be, but it could be in the order of 4- 5%.

    On this calculation then an in investor would require a nominal return from an investment into listed property of 14%.

    In the next article we will look at what type of returns investors can expect into the future and some of the positives and negatives about listed property.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-10, 19:01:21, by ian Email , Leave a comment

    The euro and its problem children

    For investors moving funds offshore into various asset classes, there is often the additional factor of selecting the appropriate currency. In terms of the 2 major currencies, the question is being asked, which issuing region has the larger fiscal woes. This is focusing foreign exchange participants on the euro/dollar trade.

    The G10 countries, their current exchange rates to the US dollar and Standard Bank G10 fixed income and forex research departments forecast is as follows:

    The global currency market is described as the largest and most liquid in the world. Because it’s a decentralised “over the counter” market, i.e. there is not one central clearing house for all trades, exact volumes are not exact, but according to the Bank for International Settlements, the average daily turnover in global foreign exchange markets exceeds $ 4 trillion.

    The foreign exchange market is often described as a perfect market because of the following factors:

    • Massive liquidity in major currencies
    • Geographic dispersion
    • 24 hour operation through the working week
    • The generally low margins on trading compared to other markets

    The modern foreign exchange market started developing in the 1970’s when countries gradually started moving from the fixed exchange rate regime to the floating exchange rates, following the collapse of the Bretton Woods system in August 1971, after US President removed the gold backing from the US dollar. Up until then countries were obliged to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value – plus or minus one percent.

    Currencies are quoted one relative to another. The first currency quoted is the base currency that is quoted relative to the second currency called the counter currency. Example the EUR/USD rate is currently 1.37, which is the exchange rate of 1 euro expressed in US dollars. i.e. 1 euro = 1.37 dollars.

    The many participants in the market include the major banks, central banks, currency speculators, companies, governments, and other financial institutions.

    There are myriad factors that influence exchange rates. Unlike a share price, which has some semblance to the future cash flows of a company, and therefore a degree of being estimated, currencies trade as relative prices and are therefore far more difficult to predict.

    Factors that affect the exchange rate are numerous and include:

    • Actual money flows
    • Expectations of changes in monetary flows, due to factors such as:
    • The relative purchasing power parity
    • Relative interest rates
    • Relative inflation rates
    • Balance of payments and
    • Budget deficits and
    • Large cross border merger and acquisition deals

    The Euro

    The Euro, launched in January 1999 at first depreciated relative to the US dollar, stabilised in 2001/2002 at around 0.95 dollars and then has generally appreciated over the years.

    It reached a high in mid July 2008 against the US dollar at around $1,60, then declined for the remainder of the year, appreciating in 2009, but falling once again in recent months on concerns about the debt problems within member countries.

    A Standard Bank foreign exchange report this week is looking for the euro/dollar to fall to 1.30 over the next month or two. The immediate concern is the debt in some Euro countries.

    Generally euro zone budget news remains poor. There is a possibility that the Q1 GDP falls back into negative territory. The consensus for the release of the 4th quarter 2009 GDP is 0,3%.

    The graph below reflects the massive short positions in the euro – i.e. foreign exchange traders are expecting a further decline in the euro relative to the dollar.

    Some of the bigger problem countries within the euro zone are Greece, Portugal, and Spain. The European Central Bank cannot afford a default on member country bonds, but at the same time they are limited as to what backstop they can provide.

    There is a special meeting of European leaders this Thursday, addressing the region’s economy and the particularly problem countries. In the meantime the world financial markets are watching what action will come from this and how the EU and ECB deal with what could spin out to be a larger problem if Greece does default on its debt.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-09, 18:09:42, by ian Email , Leave a comment

    Historical Property Returns

    Over the years listed property as an investment has proved to be an excellent investment and indeed over most measurement periods has outperformed local equities. The big question is will this be the case going forward.

    The chart below gives an indication of returns across the main asset classes over various periods. Although in nominal terms even over a 20 year period local listed property outperformed equities, because they are less tax efficient on an after tax basis, equities would have slightly outperformed. Nevertheless, listed property has been a superlative asset class with lower volatility when compared to equities.

    The 10 years performance produced a nominal 27,8% versus equities of 15,8%.

    The total return from listed property is derived from a combination of the income stream – i.e. net rental income and the capital growth (or loss). By its very nature rental income is the far more stable component of the total return. In this respect property has a close relationship with bonds, which are at their core income generating assets.

    But when investors are prepared to pay more and more for the listed property for a number of reasons, including generally lower interest rates, then investors augment rental income with capital gains. It’s because of this, that at times listed property displays “equity like” characteristics.

    For most of the last 10 and indeed 20 years, this is what occurred. The result propelled the steady rental stream into a superior investment.

    Listed real estate index nominal return components

    Source: RECM, Bloomberg

    As with all investment returns, future prospective returns from these levels are not a function of what happened over the last 5, 10, and 20 years, but more a function of the current valuations.

    We will look at this in the week.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-08, 17:23:39, by ian Email , Leave a comment

    Shorting Bonds

    There are a growing number of voices calling for the shorting of global bonds. Some, like Marc Faber, have called it the short of the century. Nassim Taleb, well known author and previous derivatives trader, reportedly said that “every human being should bet that US treasuries will decline”

    How would this work.

    Normally a government or large corporate wishes to borrow money. It issues bonds at various interest rates and with various redemption periods. The rate at which they can borrow depends on prevailing market rates, which in turn is also driven by supply and demand.

    One of the reasons that some many are calling for investors to short bonds is that the borrowing requirement at the government level of developed economies has risen sharply. With government spending up and tax collections down governments need to borrow more.
    This month, the US administration released its latest budget outlook, which forecast a fiscal deficits of US$1.55 trillion (10.6% of GDP) for 2010 financial year and US$1.3 trillion (8.3% of GDP) for the 2011 financial year.

    The chart below indicates the extent of the growing problem.

    US Budget deficit as a % of GDP

    Source: Coronation and Congressional Budget Office

    Annual fiscal deficits (i.e. fewer inflows accumulate as debt. The increased supply of debt theoretically means that investors will demand higher yields.

    Where yields rise, existing lenders suffer capital losses. Conversely as interest rates decline existing lenders enjoy capital gains.

    Therefore if the assumption is that interest rate yields should rise in future to take into account the increased supply and debt load of the governments, then the correct trade will be to sell bonds short at current yields and buy then when the yield increases (price declines).

    This is not foolproof. The 10 year treasury in the US is currently yielding a nominal 3,56%. Lending money to the US government has traditionally been viewed as one of the safer options for investors because of the almost guaranteed nature of the returns.
    So in times of global uncertainty, money has sold out of risky assets and found its way in government bonds. We saw this in 2008 and again over the last 2 days where global markets have been under pressure, this is exactly what has happened, resulting in yields coming down slightly and investors making profits on bonds.

    Investors wanting to short US bonds are also wary of a repeat of the Japanese scenario. Over many years with anaemic growth and deflation, bond yields on 10 year Japanese bonds slumped to around 0,45%.

    Low yields on what has traditionally been safe investments does not make it easy for investors. It complicates matters where some are now calling that the way to make money is to short these traditionally “safe haven” investments. This is truly not a simple investing environment.

    On that note, I trust that you have a wonderful weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-05, 16:54:24, by ian Email , Leave a comment

    Earnings versus Market Movements

    Over the long term the key driver to market returns is earnings growth. Shorter period returns can be dictated by the varying states of investor psychology, from over exuberant to overly pessimistic, but ultimately company earnings drive stock market returns. The chart below shows that these two variables track each other over the longer term, but also that they don’t track each other exactly. It therefore follows that investor returns will be dictated, to a large extent, by the growth in earnings and the initial price paid on the earnings.

    Earnings (and by extension dividends) are far more stable than market movements as a result of investor psychology. Investors typically overreact to news (and expected news) and therefore by the time investors expect an earnings drop the share price (remember markets are forward looking) will in all likelihood have fallen by more than the expected drop. The chart below shows the relative drawdown of the market compared to the composite earnings drawdown of the companies listed on the JSE Securities Exchange.

    It is evident from the chart above that the market falls by more than earnings when earnings drop significantly. The graph also shows how the market is forward looking in that it falls before there’s a collapse in earnings. This lag has typically been around one year, but it can vary. Another interesting aspect is that large market corrections don’t always occur on the expectation of a drop in earnings. The crashes in 1987 and 1998 are two specific cases of this happening.

    The large rally that started at the beginning of March last year has ensured that the market has moved back into expensive territory. While markets may continue up over the shorter term, patient investors will reduce their equity exposure and sit on the sidelines until attractive valuations once again present themselves.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2010-02-04, 14:31:57, by Mike Email , Leave a comment

    Local market view

    Local vehicle sales numbers were released for January. These are seen as a lead economic indicator. Passenger car sales rose 15% year on year, which is the first annual growth since January 2007 when it increased by 4,2%. Total passenger and commercial sales were up 12% year on year, due to commercial sales falling 4,9% in the month.

    The graph below reflects the level of the decline, where on a smoothed 3 month basis almost 60 000 vehicles a month were sold, now running at half that peak.

    Source: Nedbank

    Money market and Bonds

    Last week the Monetary Policy Committee of the SA Reserve Bank decided to leave the repo rate unchanged at 7%. This is the core rate that drives shorter term interest rates. There is still a possibility that the current target of 3% - 6% inflation is amended and we see a further 0,5% cut in rates.

    With the decline in 2009 of this repo rate, rates earned on money market remain flat at just over the 7%% level.

    The chart below reflects the clear correlation between the step down of the repo rate and the 3 month Jibar (Johannesburg Interbank Agreed Rate). Its this rate that drives the money market rates. A year back investors were getting 12% on money market. Now 3 month Jibar is steady at 7,18%. This is a low premium over inflation, which was last recorded at 6,3%.

    Source: Absa Capital

    SA equities

    The old investing adage says that, “As January goes, so goes the year.” This won’t be pleasant if this does indeed play out for 2010, given that the JSE All Share index fell 3,5% in the first month. The decline was led by Resources which fell 6,4%.

    While short term interest rates have dropped lower and lower, share prices moved up rapidly in 2009. The graph below reflects how rapidly the historical dividend yield has declined from the recent market trough in March 2009 to the current level at 2,27%. Analysts are pricing in earnings and dividends increases in 2010, which will support the current more expensive valuations.

    Source : Sharenet and Market Tracker

    If you would like to discuss your investment asset allocation, retirement projections and options, please don't hesitate to contact us.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-03, 17:05:47, by ian Email , Leave a comment

    Beware the Financial Industrial Complex

    A debate on a controversial topic, “Financial Innovation Boosts Economic Growth” was hosted by The Economist magazine last year. GMO head, Jeremy Grantham went up against Nobel Prize winner Myron Scholes and Robert Reynolds. Grantham’s view was unequivocally that financial innovation has not boosted growth, quite the contrary.

    One does not typically hear a very successful fund manager – GMO manages $107 billion - speak up against his own industry, but here are some of the points that he raises.

    • The financial services industry is a zero sum game, which collectively adds nothing but costs. At the end of the year, the collective investment community is behind the markets in total by 1%.

    • These costs have risen over the years. Despite the investment industry in the US growing tenfold from 1989 to 2007and huge economies of scale, fees per dollar also grew. He attributes this to 2 main reasons
    o Agency problems. It’s the management of third party money; and
    o Asymmetric information, where the agent has more information than the client.

    • Adding new products such as options, futures, CDO’s, hedge funds, private equity etc, only adds layers of fees and additional complication.

    • He notes than in 1965, where there was a perfectly adequate financial services industry in the US, finance was 3% of the GDP. It has more than doubled to 7,5%, which is an extra 4,5% load on the real economy.

    • His calculation is that the increase in financial services has slowed down the real economy as follows. For 100 year GDP grew at 3,5%. After 1965, GDP ex finance it fell to 3,2%. After 1982 it fell to 3,1% and after 2000 to end of 2007 it fell to 2,5%.

    • “The client world pays up precisely in proportion to how bamboozled it is by unnecessary complexity and this, among other negatives, is what the fancy new Instruments were offering: confusion, doubt, and bamboozlement.”

    These are strong views indeed. Most private investors would agree wholeheartedly with this sentiment. Because it is a zero sum game, there are certain investment practices that over time add value – conversely others that detract.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-02, 19:28:48, by ian Email , Leave a comment

    Emerging Market Valuations

    There are various views on the valuation of emerging markets. Some strategists are saying expensive, others such as Franklin Templeton, fully priced but the low interest rate environment in developed markets will continue to push capital from developed markets to emerging markets in 2010.

    Canadian research house, BCA Research, founded in 1949, has a view that Emerging market stocks are no longer cheap. They say that these markets already reflect a lot of good news, leaving them vulnerable to even minor disappointments.

    BCA Research :

    “Emerging market (EM) equity multiples have moved significantly higher in recent months, based on various valuation measures. A further multiple expansion in the developing markets would represent an overshoot of valuations from fundamentals. “

    Their view is that there are 2 possible scenarios for emerging market shares.

    1. “A full-fledged mania will develop with multiples continuing to expand,”

    2. or, a setback/period of indigestion will occur before a new upleg develops.

    They think that the possibility of a fully fledged mania is on the lower end of the scale because Chinese stocks would be at the epicentre and these shares have been trending sideways since July.

    Their view is that at current valuations emerging market shares are increasingly vulnerable to even minor negative surprises.

    The graphs presented by BCA Research give a clear indication that prices relative to historic and forward company earnings have moved up substantially from a year back.

    Franklin Templeton’s Mark Mobius view is that emerging market shares are volatile by nature and while not in bubble territory, price gains from these levels “will eventually make many emerging market stocks overvalued.”

    At the same time the fundamentals from many of the emerging markets will see a higher growth trajectory in the medium to long term.

    Money flows can drive prices over any shorter time frame, but the valuations are important. South African equities appear to be better value than the average Emerging market, but markets are not on the cheap end of the scale.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2010-02-01, 18:33:33, by ian Email , Leave a comment