Why now is a good time to hold onto SA equities

There is significant evidence to suggest that the South African equity market is expensive – more expensive than it’s ever been in the post-apartheid era (see Graph 1). With stock prices at elevated levels and price/earnings (P/E) ratios for some companies looking excessively high, one might be inclined to sell out of SA equities and into the safety of cash or other alternative assets.

At index level, the current P/E ratio of the ALSI is at a 20 times multiple (the blue line), implying that the price you pay for the general basket of shares is ‘fair’ for the next 20 years of expected earnings.

Graph 1: ALSI forward P/E versus rolling P/E

chart1

Source: Inet

 

However, when dissecting the market into basic components such as resources, financials and industrials, one is able to see that the current rating of the market is distorted by significantly overpriced rand-hedge industrial companies.

When one excludes such companies as Naspers, British American Tobacco, SA Breweries, Richemont, Remgro and MTN, the P/E ratio drops from a high of 20 times down to 11.5 times (including earnings projected one year forward).

But this is not the sole reason why investors should consider holding on to SA equities. The fundamental reason why investors should maintain their exposure to SA equities is primarily due to the fact that, over time, the market rewards those who stay invested, in both good times and bad.

Graph 2 shows the 50 worst drawdowns in the SA market, followed by the returns achieved in the subsequent 12 months of recovery. Each recovery period, more often than not, rewarded investors for staying invested!

Graph 2: The 50 worst drawdowns in South African history

chart2

Source: SI calculations

 

While the current P/E of the South African equity market does appear expensive, there are without doubt sectors and companies that present opportunities with some attractive valuations. What is of further comfort is that market volatility and drawdowns, much like the period we are currently experiencing, have occurred many times in the course of history and adhere to the laws of cyclicality.

With the negative local and global sentiment towards risky assets such as equities, it may be tempting to become risk averse and switch out of equities and into lower risk asset classes such as cash. However, time has shown that investors are better off resisting the temptation to sell out of their long-term plan, and not reacting to short-term market movements.

If you stay invested over the long term, on average, the outcome is usually better than the market losses experienced in the short term. The skill is to ensure that you have the correct underlying strategies to navigate this volatility over the long term and to stay the course. Along with the investment committee at Octagon Asset Managers, we at Sanlam Multi Managers are constantly managing our strategy and the underlying asset managers who we appoint. It is of utmost importance that the underlying participants will first and foremost contribute to us meeting the objectives of our clients, within acceptable risk tolerances and parameters, and help navigate the current and ensuing market conditions over the long term.