May 2006 saw the edge being taken off global market prices, and volatility, long absent, has set in. Asset prices have experienced strong gains from lows three odd years ago, and so a degree of shake-up was expected. But, the BIG question remains – have prices corrected enough, or is there more to come?

The JSE All Share index gained 73% for the 12 months to end of April, reversing some 2,7% in May, and almost 7% from the peak of 22094 reached on the 11 May. This brings the return for the last 12 months to 53,3% and the 3 year compounded average to a phenomenal 37,9%, lifting the more normalised 5 year average to 20,8% compounded.

Clearly the recent gains to the end of May have been fairly extraordinary. May’s decline of less than 3% was therefore rather pedestrian.

The local market reached a low point in March/ April 2003, when the average price to earnings multiple of all shares reduced to around 9 times.

Subsequently the recent strong performance has come from a combination of very favourable global markets, an abundance of liquidity and a very cheap starting base.

And Now:

Locally, there is no doubt that share values are not at historical highs, but at around 15 times historical PE multiples, are still running ahead of long term valuation levels. At the same time company profits and returns on investment and capital are running at very high levels and so investors generally are paying a high price for high levels of profitability.

In this scenario, despite the fact that company profits should remain firm, albeit off a higher base, prospective returns for investors here out, should fall in line with the longer term average of around 18 - 20%.

Don’t be surprised to see a period of sideways movement in share prices, or even a dip back to the 17 000 level until normalised values again become apparent.

Article on Trends in Investments

In June 2003, I penned an extensive report titled “Five Trends in Investments”, where I outlined what I believed were 5 main themes, and which in turn guided my investment focus and client recommendations.

While I underestimated the recovery in the main US and European equity markets, interestingly most of what I elaborated has proved to have been accurate. For your interest, if you require a copy of this report, please mail me.

I am currently working on a complete update an in attempt to provide a secular view of economic and financial trends over the next 3 – 5 years, which will again guide my investment process.

Conclusions:

• Commodity prices are likely to endure more correction, given the 4 years of very strong gains.

• Longer term I expect gains in the prices of commodities, including gold relative to a depreciating US dollar.

• Global Equity Markets are not expensive on an historical or forward looking basis, but the prospective returns from US and Europe equities is likely to remain muted for some time.

• Asian equity markets, while also subject to plenty of volatility, still appear to be more attractive given their growth prospects and valuations.

• Local equity valuations are tending to the more expensive levels. Long term investors should definitely remain invested, but with lower exposure. Prospective returns here out from the higher valuations are likely to be more subdued, falling back into longer term norms.

For a long time now, financial markets have not been disciplined. Higher interest rates should steadily reintroduce some discipline, but unfortunately it’s not always as simple as that – often it’s only some crisis that brings down valuations to longer trend norms.

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Please note that this report is not regarded as specific advice. If you require specific advice from an independent advisor, please don’t hesitate to contact me for a confidential discussion. E-mail me your contact details to ian@exsequor.co.za and I will mail you a copy of my Value Proposition.

Posted: 2006/06/02 14:08 View Archive

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