Equities against inflation over the last 5 years
Equities offer an outstanding hedge against inflation over the long-term, but lengthy periods of returns below inflation can and do occur. Figure 1 illustrates the JSE All Share Index’s return over 5-year rolling periods against inflation. Each point on the graph informs us of the market’s return (blue line) over the past five years relative to inflation (red line). As at 2019, the JSE over the past 5 years has delivered returns well below inflation and these sub-optimal returns rival previous painful periods in 2013, 2003 and the 1970’s.
Figure 1. FTSE/JSE All Share rolling 5 year returns vs inflation. Source: Morningstar, Northstar Asset Management. May 2019.
The last decade is a story of two halves
The low returning environment of the past five years is illuminated (figure 2) further when we compare the first five years of the past decade to the second five years. The following applies:
Figure 2.Market return breadth of the last 5 years vs the previous 5 years. Source: Bloomberg, Northstar Asset Management. May 2019.
Best performing stock
- The best performing stock on the JSE over the first 5 year period returned 91% (dark blue bar).
- The best performing stock on the JSE over the second 5 year period returned 45% (light blue bar).
- The best performing stock on the S&P over the second 5 year period returned 64% (red bar – in dollars).
Worst performing stock
- The worst performing stock on the JSE over the first 5 year period returned -39% (dark blue bar).
- The worst performing stock on the JSE over the second 5 year period returned -71% (light blue bar).
- The worst performing stock on the S&P over the second 5 year period returned -46% (red bar).
Average performing stock over the two periods
- The average stock on the JSE delivered 20% return over the first 5 year period (dark blue bar).
- The average stock on the JSE delivered 0% return over the second 5 year period (light blue bar).
- The average stock on the S&P delivered 9% return in dollars over the second 5 year period (red bar).
Number of stocks that delivered positive returns
- 83% of stocks on the JSE produced positive returns over the first 5 year period (dark blue bar).
- 58% of stocks on the JSE produced positive returns over the second 5 year period (light blue bar).
- 78% of stocks on the S&P produced positive returns over the second 5 year period (red bar).
The message in the data is that investors were not rewarded for being invested on the JSE over the past five years. Our equity market has underperformed inflation, other domestic asset classes, most emerging markets and developed markets too.
So what is the main cause of the JSE underperforming?
Companies are not islands, they are living entities that exist and operate within the ecosystem of the economy. Although levers can be pulled by managers of businesses to outgrow the economy in the short-term, this growth rate inevitably converges to the rate of GDP or economic growth (at nominal GDP) in time. Low or no growth economies lead to low or no growth companies and for listed companies, this translates into ailing share prices.
The graph (figure 3) shows the extent to which the earnings of companies listed on the JSE follows GDP growth.
Figure 3. South Africa nominal GDP growth vs market earnings growth. Source: Bloomberg, Northstar Asset Management. May 2019.
Notice two important features of the growth. Firstly, how GDP growth and thus earnings growth have been trending lower since peaking in 2007. Secondly, that GDP growth tends to lead company profitability and considering SA GDP growth has literally, fallen off a cliff of late, it should not surprise investors that forthcoming company results will negatively surprise the market as has been the case over the past quarter.
Are returns likely to improve?
We indicated that the JSE was showing real value at the end of 2018 and sent our clients a video of our reasoning for this view, since then the local market enjoyed some buoyancy, only to retreat in the past few weeks. Once again, we are noting value building-up on the JSE. However, to sustain higher share prices, company profitability must be fueled and this is contingent upon an improving economic backdrop. We certainly hope that Cyril Ramaphosa and his new cabinet appreciate the gravity of the situation.