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In the bad old days of the 1970s, after the gold price was let off its $35/oz leash — equal to R25/oz when a rand cost $1.40 — the most important SA economic indicator was the price of gold. When asked, then finance minister Owen Horwood would say the gold price would fluctuate, as it surely has done ever since 1971. My joke of the time was: “Yes, the gold price would fluctuate, but I could not be sure in which direction, up then down, or down then up?”
This is of course true of the prices of all well-traded securities, as it has been for the JSE all share index. It has the character of a random walk. On average the index has gained almost 1% per month since 1971, enough upward drift to have increased the value of the index by about 500 times. The price of gold has increased at a slightly higher average monthly rate of 1.2%, raising the gold price in rand by over 1,100 times with similar volatility — the ups and downs have had a similar range.
Had the dividends paid out by JSE-listed companies been reinvested, a portfolio based on the JSE index, up five times, would have appreciated by about 4,100 times, an average compound rate of 15.6% per annum. The JSE and gold price were similarly volatile, making the JSE, with dividends reinvested in the index, a clearly superior investment to owning barren gold.
Yet the returns from the share market could have been compounded at a far faster rate, with similar risk, had investors or their agents, such as pension fund managers, been able to successfully time entry into or out of the market. That is, buy when the market was about to recover, and sell when the market was overextended and falling away.
It is the holy grail of active investors to get the timing right. And while the average manager may not do better than the market average, a minority will always do so, and some handsomely enough to keep them searching for the secret timing sauce.
In principle the way to beat market returns is clear enough. It is to find a theory — a model — based on past performance, well understood as incorporated in the model, that could enable the investor to judge that the market at the time of inspection was undervalued or overvalued relative to the predictions of the model, thus offering the investor a margin of safety to buy or sell.
A model of the JSE that included the strong influence on it of other emerging equity would have estimated that the exchange was significantly undervalued in March 2020, given prevailing earnings from the JSE and an SA risk premium. Hindsight tells us that buying the JSE then would have been excellent timing.
Between then and last month the JSE would have nearly doubled its rand value — including dividends. The S&P lagged the JSE, providing total rand returns of 65%, while the emerging-market benchmark provided a far lower total return of 31%.
What the market timing buyer could not have easily known at the height of the Covid lockdowns is how strongly JSE earnings would grow after Covid to help the investment case. JSE earnings grew significantly faster than they did on the S&P or other emerging equity markets, helped by higher prices for our metals and minerals.
JSE earnings also grew faster than prices. Price-earnings ratios have therefore fallen rather than risen with the more valuable JSE. It will be up to those with the secret sauce to decide whether the derated JSE still offers a margin of safety.
The tragedy of the earnings boom for SA companies is that it has not translated into more output or more investment, thanks to government malfeasance and incompetence that any sage model builder is unlikely to think will be corrected any time soon.
This article originally appeared on BD Live.
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