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    Seed Weekly - Earnings Jump on the JSE

    An important part of Seed’s multi management process is performing monthly asset class valuations using our in-house quantitative models. This process covers all the local and global asset classes that are suitable for inclusion in our multi asset class funds and model portfolios. The output of these models guide our tactical asset allocation decisions, where we under- or overweight certain asset classes in the short term, compared to our longer-term target weights.

    Our local equity model has ranked local equity as expensive for around 5 years now, and our models currently indicate that the market is within 6% of most expensive valuations since 1986. One of the inputs of our valuation model is the Price/Earnings (PE) ratio, which is the multiple of annual earnings investors are willing to pay for a certain company, sector or the market as a whole. We have found that the total market PE is not a great leading indicator of stock market returns over the short to medium term, but does give a good indication of what to expect over the long term.

    At the end of February, we have seen the market PE ratio come down from an all-time high of 23.5 to a less extreme, but still expensive, 19.8. The market PE ratio can decrease when either company share prices go down, reported company earnings go up, or both. During February, the JSE fell -3.1%, which accounts for some of the -16% drop in PE. We therefore did some further digging to investigate the earnings increase that would account for the rest of the change.

    Chart 1 : JSE All Share Index PE ratio since September 2011 (low of 12.1)

    Source: INET (28 March 2017)

    Investigating the PE ratios per sector on the JSE, it is clear that some very strong earnings had come through in the Resources sector, resulting in the PE dropping from 29.3 to 15.5 times. At face value, it seems as if Resources has gone from being as expensive as the Industrials sector to being as cheap as the Financials in a single month.

    Chart 2 : Sectors PE Ratios

    Source: INET (28 March 2017)

    This again highlights one of the pitfalls of using a historic PE ratio – a sector can appear expensive, just because the market already places a premium on strong earnings that have just not been reported yet. As soon as reporting season starts and the higher earnings come through from the data providers, a high company or index PE ratio can unwind very quickly.

    Table 1 : Illustration of the resource shares with significant changes in reported Earnings per Share during February

    Source: INET (28 March 2017)

    Within the Seed Balanced Fund, each of our two local equity managers have a wide mandate and are not restricted to specific sectors or industries. On a sector level, the consolidated local equity exposure within the Fund does not differ vastly from the JSE All Share Index at the moment. The combined portfolio has an active share of 55% with a slight overweight to Industrials, slight underweight to Financials and an on-weight Resources exposure.

    Kind regards,

    Cor van Deventer

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2017-03-29, 10:19:56, by Mike Email , Leave a comment
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