A market correction in the making? JOHANNESBURG – It’s something that investors hear quite often during a bull market: "Sell your stocks – the JSE is about to experience a major correction." This advice is currently doing the rounds again in some circles. Against the background of the imminent tapering of the Fed’s quantitative easing program, expensive share prices in especially the industrial sector of the local bourse and a steady supply of negative news flow, some believe the time to sell is now. The short-term case for a correction Dwaine van Vuuren, founder of PowerStocks Research, says apart from many technically overbought conditions that currently exist due to the recent three-month run-up in the markets to new all-time highs, there is indeed a toxic mix of factors combining that virtually guarantees a correction of the order of 8% to 12% in the near future. “The most glaringly obvious is the current JSE Top40 P/E (price-earnings ratio) of around 19 times. As the chart below shows, nothing good has ever come one-year out from P/E’s at current levels and due to a collapse in earnings of the JSE’s underlying constituents recently, and next earnings season some four to five months away, the JSE valuation is currently a bug looking for the veritable windshield,” says van Vuuren. He says the JSE needs to correct around 20% to get back to the dotted regression line (normality), but given that the assumption is that we are in an on-going bull market then this is more likely to be of the order of 8% to 15% at most before aggressive buying sets in again. “Timing exact peaks in the stock market is a difficult business and at best you can examine the probabilities of a correction and act according to those, on the understanding you may have to wait weeks to months to see the event come to life (or not at all), but right now the odds are on the side of a short-term, not insignificant correction, quite possibly even re-testing the last major support at 33 500 for the Top40.” A broader picture Dr Adrian Saville, chief investment officer at Cannon Asset Managers, says the macro environment locally, does point to some reasons for concern. Sluggish economic growth prospects, inflation that is likely to exceed 6% for the balance of the year, anxiety over strike action and challenges in the labour market point to difficulty for South African firms. From a valuation perspective, at the aggregative level, the JSE is slightly on the rich side of fair value, he says. This is largely the result of large, highly rated industrial companies – a small number of names that represents a very large part of the market – that are on very elevated multiples, he explains. These include SABMiller, Aspen, Shoprite, Naspers and Richemont. Saville says although these companies certainly justify premium ratings, the premium has pushed beyond what he would consider to be appropriate. “I think there are some parts of the JSE that are very expensive and do look ripe for correction.” However, midsize and smaller businesses in this sector, do not strike him as being excessively priced. Also, the financial cluster looks relatively fairly valued while the resource basket looks cheap. If the large industrials do correct, the market will correct, because it will not be immune to contagion, he says. However, a correction in a share price, is not necessarily equal to a bad investment. “If you pay a good price for good businesses today and the share price corrects, that doesn’t turn it into a bad investment, it means you have got price volatility. It is a bad investment if you have permanent destruction of capital, if you have heavily overpaid for a business.” There are some parts of the JSE where I think you are right now heavily overpaying and those will be poor investments, he says. “If large companies correct, other more fairly-priced companies won’t be immune to correction, but they will remain good investments because they are correcting off an investable base. whereas the large companies are correcting off a very expensive base.” Timing the market Saville says the decision to exit the market is a complex one. An investor has to consider the costs involved in getting in and out of the market. This includes transaction costs, the difference between bid-offer spread and perhaps tax costs and will vary depending on the nature and the size of the investment, he says. The implication thereof is that investors will need to be right more often than not. Saville says the available evidence suggest that an investor would probably need to time the market correctly in about two-thirds of cases in order to justify the costs of transacting. Investors also need to consider how likely they are to be right. “The available evidence suggests that on balance people are not really as good at either forecasting or timing the market,” he says. Getting out Daniel Wessels, financial advisor at Martin Eksteen Jordaan Wessels, says he would not advise investors to sells their local shares at the moment. Trying to time the market, does not add value, he says. Wessels says 2012 was an excellent example where investors tried to time the market and lost out on a significant surge in share prices. (The All Share gained about 23% last year.) Perceptions of what is going to happen is heavily influenced by recent events, and sentiment plays a huge role in predictions, he says. A study Wessels conducted in 2011, analysed the monthly 12-month return expectations of institutional investors and financial planners using data from the Institute of Behavioural Finance’s Investor Confidence Index survey between June 2007 and May 2011. Wessels says investors will generally do better by having a definite investment policy that specifies a more or less fixed asset allocation strategy. It is unlikely that investors will create any value by actively switching between asset classes based on their own or expert opinions about possible returns in the future. Investors should remember that “losses” not only mean declining investment values, but also the opportunity cost of not investing in performing assets, he says. In this regard, he quotes Peter Lynch, all-time great fund manager and investor: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Posted on: Wed, 04 Sep 2013 06:11:43 +0000