Analysis By Bernard Joffe (Editor, The "Richesse Letter")
"fundamentals" as applied to stock market
analysis refers to the study of the myriad background
factors which affect the value of securities and hence
their price. Fundamentals include the following two
fields, macrofundamentals and microfundamentals.
This term refers to the
financial, economic, political and social environment in
which stock markets function. The term embraces such
factors as inflation, interest rates, fiscal policy,
foreign investment, currency fluctuations and so on.
Let's briefly consider some of these factors and their
likely influence on the stock market.
Escalating inflation, of
the type seen all over the world during the seventies, is
a consequence of the "over-production" of paper
money, in comparison to the available supply of goods and
services. In such an environment all "things"
with a paper money value will become more expensive. This
applies particularly to precious metals such as gold and
Conversely when countries
bring inflation more under control, as happened in the
major industrial centres during the eighties, the prices
of these metals decline. Insofar as an increase in the
money supply may prove stimulatory to business, and
generate improved corporate profits, inflation has also
tended to favour investment in sound non-mining shares
such as Industrials and Financials. Note however that
there are many exceptions to this rule.
Stock markets love
declining interest rates, particularly short term ones,
and as a rule react positively to them. The general
reason for this is that individuals and companies decide
that they can receive a higher return on their savings by
investing in the markets. Conversely when the monetary
authorities allow these rates to rise (to cool off
inflationary pressures in the economy) the stock market
tends to decline, as happened in 1969 and again in 1987.
With increasing taxes,
consumers have less money to spend, hence shares of
consumer-oriented companies usually become adversely
affected, whereas a tax-reduction is often stimulatory to
the stock market.
A developing country like
South Africa is unable by itself to generate sufficient
capital to produce economic growth commensurate with the
expansion of the population. The amount of capital
foreign entrepreneurs invest here (considering the
ongoing violence, strikes, civil disobedience, etc.) will
largely determine our economic well-being, and may
clearly impact negatively on share prices and influence
the progress of the stock market.
Another aspect to consider
is the possible lifting of exchange controls at some
point in the future. Even minor adjustments to these laws
could produce net outflows of capital as a result of the
larger corporations' ability to transfer capital to
destinations outside SA, where the risk versus reward
ratio is likely to be more favourable.
Political stability and
the rate of inflation are two of the factors in a country
that influence the supply and demand for its currency,
which in turn determine its value.
A decline in the currency
will often cause a country's exports to become cheaper to
foreign buyers, and hence will be beneficial to the
shares of export-oriented companies. On the other hand,
imports become more expensive, and this tends to
adversely affect the profitability of import-oriented
companies. Of course if the country's trading partners
have equally weak (or equally strong) currencies, then it
will lose this relative advantage.
An example is the
devaluation of the British Pound when Great Britain
withdrew from the European Exchange Rate Mechanism (ERM)
in 1992. The Pound devalued by around 14% relative to its
major trading partners in Europe and the US. The impact
on the stock market was positive, because Britain's
exports became less expensive and therefore more
attractive to foreign buyers. In 1992, 33 billion dollars
of foreign investment flowed into the country. In Europe
at that time only Spain could boast such a substantial
amount of foreign investment.
This term refers to those
factors affecting the profitability of individual
companies or groups of companies. Included in this
category are such factors as quality of management, net
asset value, debt and equity ratios, new product
Indeed virtually all the
parameters normally disclosed in a company's financial
statements fall within the ambit of the microfundamental
Also very much a part of
this section is the question of product-demand. For
instance: In recent years the health allegations against
asbestos-producers and their products have adversely
affected their shares.
Similarly reports of the
development of cheap non-platinum-based catalytic
converters for motor-car emissions have depressed
platinum shares from time to time.
concerns itself with the question of obsolescence - for
instance the development of the fax machine was a
tremendous setback for the manufacturers of telex
Perhaps the major problem
confronting the fundamental analyst is that of timing,
since the stock market nearly always makes its major turn
before the economy does. Historically, one can show that
bull markets (upward market-price surges) start when the
tide of business is low and at an ebb and gloom is
Conversely bear markets
(downward price-surges) start at times of great
prosperity, when the economy is so to speak bursting at
the seams and optimism reigns. It is therefore not
difficult to see how anyone who relies solely on the
fundamental approach to stock market analysis is prone to
be late in calling the turns in the market.
Finally the fundamentalist
also frequently has difficulty in coping with mass (or
group) psychology, otherwise known as "herd
instinct." This implies that when the public base
their investment decisions on high profile statements by
political or business leaders, such action is almost
invariably "too late," since the market will
have already discounted them.
This is one of the reasons
for "overheating" of the market. Sentiment will
buoy (or depress) the market until it is no longer a true
reflection of value, at which stage a correction becomes
a distinct possibility.
To quote one example: In
1949 the price/earnings ratio of the Dow Jones
Industrials on Wall Street reached a depressed level of
8. This means in effect that investors would only pay $8
for $1 of future earnings. Contrast this with the
position in November 1991, when the same parameter
reached a level of 29. Investors would pay $29 for $1 of
In brief, the
fundamentalist may be able to work out what a given
company will earn, but has no way of determining what the
investment community will be prepared to pay for those
Fundamental information is
of course quite easy to come by. Newsletters, newspapers,
financial magazines, brokerage house letters, etc. are
all full of information and opinions at both the macro-
and microfundamental levels.
Few people however have
the time to read all this information, much less weigh up
the often contradictory evidence and opinions presented.
Furthermore even if they do, will they have the courage
to stick to their conclusions when others voice their
equally forceful but opposite opinions?
Another problem facing the
fundamentalist is possible bias from the person
presenting the information.
Appended below is an
alphabetical table of South African sources (printed and
electronic) which may contain fundamental information of
use to the investor. Following these are two worldwide
publications, one from Britain and the other from