South African shares: Is this the turning point?

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The present financial crisis has been with us for some time now and has affected virtually every sector of the economy, causing wide-spread damage. Developed economies like those in the US, Europe and Britain, as well as some emerging countries have already announced various bail-out packages and emergency measures to try and salvage their financial systems. At the same time, they have started to cut interest rates to improve liquidity and stimulate economic growth.

Economic conditions in the US have however worsened so dramatically that the Federal Reserve Board (the Fed) has decreased interest rates to a range between 0,00% and 0,25% to prevent an economic meltdown and the concomitant negative effects of deflation.

South Africa has not been directly involved in the forces driving the financial crisis. However, although there has been no need for local emergency measures or bail-out packages, we are not unscathed. We were directly affected when foreign investors dumped large volumes of local shares under the guise of ‘risk aversion’. The money that flowed out of the country also significantly weakened the rand against other currencies. The serious decline in international commodity prices (for which the weaker rand has not fully compensated) and the fact that our economic growth is so dependent on the economic health of the rest of the world, albeit indirectly, are also affecting us.

The oversupply of liquidity created worldwide to prevent deflation and stimulate economic growth has undoubtedly already started trickling through to shares. The MSCI World Index and the MSCI Emerging Markets Index have already seen respective increases of 23,1% and 30,8% from their 20 November lows.

Our local stock exchange also reached a cyclical low on 20 November. Since then the FTSE/JSE All Share Index and the FTSE/JSE Top 40 Index have climbed by 28,7% and 30,9% respectively. Medium and small capitalisation shares reached a low on 27 October, but have also improved by 27,5% and 10,0% respectively.

The resources sector has improved by 52,6% since its 20 November low. This was mainly thanks to the Gold Index which increased by 55,5%. Since 17 October the financial, property and industrial sectors have also increased by 17,8%, 28,1% and 18,0% respectively.

Several factors could have a further positive effect on specifically local shares.

The Reserve Bank seems to have succeeded in containing inflation. The inflation rate has dropped for two consecutive months, and we have seen the first 0,5% repo rate cut. Further interest rate cuts are possible and will provide much-needed relief for consumers and our industrial sector. However, sharp declines could be hampered by a weaker rand which could once again stimulate inflation. A moderately weaker rand could counteract the lower international commodity prices and have a positive effect on our resources sector.

Local share prices have dropped to such low levels that shares offer good value for money at present. The price-earnings (PE) ratio for the FTSE/JSE All Share Index (see graph below) has already reached a turning point and is currently 10,1 as opposed to the 24 year average of 14,4, which represents a discount of 42,6%. The turning point is lower than the 1998 emerging market crisis low and just higher than the 2002/2003 bear market low.

The dividend yield of the FTSE/JSE All Share Index (see graph below) also reached a turning point and is presently 4,1% as opposed to the 24-year average of 2,7%, which represents a discount of 51,9%. The turning point is also higher than the highs of the 1998 crisis and the 2002/2003 bear market.

In short, although value has emerged, the financial crisis is not over yet and big surprises may still lie ahead. Tread with caution.

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