The last 6 months on the JSE have been exceptional. For the 2005 year,

1998 decline.

But there is absolutely no doubt that as the JSE All Share index approaches

and then moves through the 20 000 level, the risk of capital loss increases

because of more expensive valuations. Share valuations are now not cheap running

at over 17 times historical profits, when compared to the longer term average

of around 11,5 times and the 10 year history of around 14 times.

When looking at the long term graph of the rating of the JSE, it is clear that

for long periods of time it moves far above and far below averages. It also

worth noting that while it has moved up in the recent 3 years, it remains below

the peaks set in the early to mid 1990’s.

On a trendline earnings basis, share prices were at these more stretched valuations

in 1987 and 1969. Because the price to earnings ratio is a function of both

the price and the underlying earnings, it stands to reason that the higher the

rate of earnings growth, the higher the price that can be justified (a businessman

will be prepared to pay a higher price for a business generating super profits).

In the last few years, the rate of growth of earnings has been above long term

trendline average, for a number of reasons. This includes margin expansion for

many importers, steadying rand, high commodity prices, government capital expenditure

and low interest rates etc, all working together to fuel the economy and thus

company profitability.

The reality is that first world investors are increasingly buying into the

ongoing emergence of emerging markets, of which South Africa is one of many.

Emerging markets have delivered excellent returns in US dollar terms, and will

continue to feature as high priority for global investors in their search for

yield and growth.

Investors should remain committed to an investment plan, and not try and time

the market in an out. But as valuations start to approach peaks, it is important

to become more wary.

The local market is in a bull run - it still may be too early in calling the

top, but it is definitely not too early to sound the alarm on values.

As prices move up ahead of long term averages, so conviction levels decline.

As I mentioned in the last report, as value decreases, look to avoid putting

capital at risk which can suffer permanent losses. I believe that the process

involves having some flexibility in portfolios and reducing exposure as value

disappears.

While markets are on the up and the general consensus is that prospects for

a decline are remote, it’s important to have a plan of action.

For

the detailed Market Focus newsletter, please click here.

Please note that this report is not regarded as specific advice. If

and I will mail you a copy of my Value Proposition.

Sincerely

Ian de Lange

February 2006

021 700 4800

Posted: 2006/02/08 08:46 View Archive

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