Has the JSE forgotten the sky is falling on our heads?

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By Shaun le Roux

In the old fable, Chicken Licken runs around telling everyone that the sky is falling down after an acorn falls on her head. Apparently there are a few versions of this story, but the one I enjoy most is where she enlists the help of Foxy Loxy to warn everyone and he promptly eats all Chicken Licken’s friends. Go figure.

The South African economy is in a bind. The fourth quarter of 2007 slowdown was abrupt – disregard the anomalously robust GDP number. Retail spending hit the skids and conditions have worsened in the first quarter of this year. The already weak manufacturing sector has been squeezed further by Eskom-induced production constraints, although the weaker rand may ease the pressure somewhat. The energy-intensive mines have been forced to cut energy use by 10%, which is also having a significant impact on their production.

Ordinarily, one would hope that the SA Reserve Bank would come to the rescue with interest rate cuts to stimulate spending and investment, but this time round spiralling food and fuel costs appear to have removed this opportunity. Instead, if the SARB adheres strictly to its inflation-targeting mandate, it should be more likely to raise rates than cut them. Yet, if the bank is honest with the public, it would have to admit that the bulk of the current wave of inflationary pressure is beyond its control and very much the result of global supply and domestic currency shocks. Hence, there is very little it can do to beat inflation down this time without seriously damaging the country’s economic output – at a time when it is already under pressure. The best that it can hope for is a strong rand to keep the lid on inflation, an increasingly unlikely event in current market conditions.

And yet despite all of this the JSE came within 2% of its all-time highs earlier this week. Unfortunately, the feel-good factor has been restricted to a mere handful of Resource shares that have been trading very strongly, and market breadth has been terrible, with the bulk of the market, predominantly domestic, still very much bogged down by the woes on the global financial markets and the sogginess in the SA economy. A sharply
weakening rand has also provided support to the rand hedges, which dominate the All Share Index, and in particular the mining shares.

It is interesting to compare the performance of the JSE in rands to its performance in euro terms (refer graph below). Until yesterday the JSE had recovered 23% in rand terms from its January lows, but only 6% in euro terms.

This speaks to the impact the weakening rand has had on the performance of the rand hedges, and the miners have been the strongest beneficiaries as commodity prices have been very strong at the same time. Commodity price strength has been a symptom of both a weak dollar and continued robust demand, with supply still very constrained. Commodities are seen as a hedge against inflation, which is rising in many emerging markets, hence investment demand in this area remains strong.

As this complex continues to go up while other financial assets go down, it will continue to attract money. It is interesting to note that as of yesterday the JSE All Share was up around 7% in rand terms in 2008, but if you stripped out the performance of two shares, Anglo American and BHP Billiton, it would be down!

Investors should be aware that the recent strength on the JSE masks underlying weak performance by the broader market. We have seen aggressive selling by the foreigners in domestic shares. Redemptions in unit trusts have hit the smaller cap shares very hard recently. Liquidity has died and buying appetite is largely absent. This is starting to look like capitulation and presents wonderful opportunities, but a reversal in fortune is unlikely to be imminent.

All the recent strength has been in a narrow part of the market (the Resources) and the stocks are starting to look quite expensive and very overbought in the short term. But as long as Chicken Licken and Foxy Loxy continue running around telling everyone that the sky is falling, it is difficult to see this game changing in the near term.


Source: I-Net Bridge

Source: Shaun le Roux, Alphen Asset Management, March 7, 2008.

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