Rand Weakness SmartRand

JSE protects against rand weakness

Given the significant rand weakness over the last few weeks and the very recent losses on the JSE, some investors are starting to wonder if they should ratherRand Weakness SmartRand invest their money overseas and away from our volatile economy. This type of thinking is very similar to what was experienced in the early 2000s when rand weakness was apparent against all  major currencies. Many thought rand weakness would continue to the point where the currency had no value.

History proved  those who sent money out of the country to protect against rand weakness at that time made a mistake. Doing so this time might repeat the error.

The JSE protects against rand weakness and US inflation

With the recent rand weakness and all the negativity surrounding the South African economic and political situation, I am often asked whether investors should simply invest their money overseas. This is a completely understandable question. But it might not be your best investment strategy to protect against rand weakness. In my view, unless you think Zumanomics will destroy the SA economy, you must maintain a sizable investment in the JSE to ensure long-term investment success.

Many of the biggest companies on the JSE earn the majority of their money from outside of SA. This means any rand weakness will  increase profits, which is positive for their share prices in the longer term.

The fund managers that I believe provide the best investment research, Cannon Asset Managers, created the graph below. It shows the return of the JSE in US$ (green) against the US inflation rate (blue) and the US stock market (red). As you can see, even with the recent rand weakness and the sharp drop in the JSE, SA investors are still handsomely beating the US inflation rate, as well as the US stock market, over the last 10 years.

The graph is interesting because it shows the JSE has beaten US inflation and the US stock market over all the preceding 10-year periods from 2006 until now. (You can also see the JSE underperformed in the 10-year periods from 1997 to 2006.)

Rand weakness in perspective

Compiled by Cannon Asset Managers. Source: Bloomberg

Given this information, even the most hardened afro-pessimist would have a hard time arguing that it is always better to invest outside of SA to protect against rand weakness. For me, the graph further illustrates the value of a properly diversified portfolio of shares to give you exposure to the JSE and offshore markets. The primary reason for this diversification is to protect against stock market events that are totally unpredictable, but massively damaging to investors.

How much must I invest offshore?

If you plan to spend your life in SA, I feel you should have an offshore investment allocation that equates to 20% to 40% of your net wealth. It’s important to note that you can get a lot of this offshore allocation via local unit trusts, exchange traded funds (ETFs) and even some of the pure rand hedge shares.

If you are planning to spend a large portion of your time (and therefore your money) outside SA, you should invest 35% to 70% of your money offshore. More importantly, you must invest a significant portion of this money directly overseas, i.e. using your offshore allowance. In so doing you can access the money from overseas when required.

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Complex investment products

Complex investment products: Caution is advised

Be wary of complex investment products

Over the last few weeks I’ve had an increasing number of enquiries from readers about a new complex investment product offered by a life assurance company. Complex investment productIt offers access to low-cost, indexed investments with a fee structure that will apparently benefit investors. This is the latest in a long list of complex investment products created by life assurance companies to attract new investors. While I enjoy getting questions from readers, I always take a deep breath when they ask about new products from insurance companies.  I know that I will have to trudge through mountains of marketing-speak in trying to decipher if this new product will really be good for investors. So far, I have found that some of these complex investment products are better than others. But none of them have been compelling enough for me to place my or clients’ money in them.

Complexity is not an ally

If an investment product cannot be properly explained on one A4 page, you need to be very careful. If it takes a brochure of more than 10 pages, be extra cautious. It may just be a complex investment product. I am not implying that you are being scammed, but rather that there are potential pitfalls that you need to investigate and avoid, especially with complex investment products. The law does not protect you if a complex investment product provider can prove that you have been fully informed about an investment. This is why insurance companies issue massive contracts with their products and remind you repeatedly to read them. If anything goes wrong in future, they can simply refer you to clause 607 on page 724.

To me, simpler is always better with investments.

With complex investment products you, be aware of the implications of these products’ intricacies, as well as the usual investment risks. These are difficult enough to understand on their own. I cannot convince myself that complex investment products issued by insurance companies are totally favourable to you. I am more certain that they are good for the complex investment product provider. After all, they use teams of actuaries who spend time calculating probabilities of events and how the company can profit from them. I prefer to avoid dealing with investments created by actuaries because they understand the odds better than I do. I am not sure that I will always benefit to the same extent as the complex investment product provider.

Investment costs are declining

We all know that investment products have been too expensive for too long. Thankfully, I believe the tide is finally turning in consumers’ favour.

You can now buy a unit trust from an insurance company for a total annual fee of 0.59% per year, with no additional administration fees and a minimum debit order of R200 per month. (Don’t believe me? – Check out the SIM equally weighted Top 40 fund.) You can invest yourself, which means no initial fees or advice fees to insurance agents.

Five years ago I would never have dreamed of seeing one of SA’s largest insurance companies offering this type of investment. I feel this is a better bet than the Satrix Investment Plan, because I think the administration charges are too high for smaller investors. There are also high quality asset managers who will manage share portfolios for 0.50% per year and unit trust companies that will offer diversified unit trust portfolios with annual fees of 0.35% (to investors with more than R10m to invest). These are the fees that were being charged to multi-billion rand pension funds a few years ago.

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Economic growth is unrelated to stock market performance

Economic growth cannot predict stock pricesWill it surprise you to know there is almost no relationship between economic growth and  stock market performance? If you are spending time worrying about economic growth when making your investment decisions, it’s likely you are wasting your time.

Warren Buffett, during his most recent shareholder’s meeting, told investors he has never made an investment decision based on what he thinks economic growth is going to do. One of the greatest unit trust fund managers of all time, Peter Lynch, remarked: “If you spend 13 minutes a year trying to predict the economy, you have wasted 10 minutes.” This might seem surprising to most. It seems intuitive that investors must have a good “feel” for the direction of  economic growth, because companies will either be operating with economic tailwinds or struggling with difficult conditions. If the economy is doing well, one would expect more opportunities to make profit, which should translate to rising share prices.

It’s not about economic growth, or the economy itself

There is a great study by Holger Sandte, Chief Economist at WestLB Mellon Asset Management, in which he covers a range of topics about how share prices and economic growth relate. The finding that is most interesting to me is that there is absolutely no relationship between the direction of share prices and  economic growth.

I can partially understand this finding, because the stock market is forward-looking. It’s always trying to anticipate what’s going to happen. Therefore current prices are based on investors’ future expectations.

In contrast, economic growth data is always historic. It can only tell us what has already happened. If we believe stock prices are forward-looking, it might make more sense to see if share prices relate to economic growth data from a later date. For example, will this work if we review the direction of the stock markets from January to March and compare this data with economic growth from April to June? Sandte’s study could not find a meaningful relationship with such a delayed comparison. In other words, economic growth data is interesting, but not relevant to equity investors.

If economic growth is not, what is relevant?

Consumer confidence is a totally different matter. According to Sandte’s study, there has not been a prolonged period of time when US consumer confidence and share prices have moved in opposite directions. If consumers are feeling confident, it will translate into rising stock markets over time. The good news for investors is that consumer confidence is regularly measured and published in the US and many other countries around the world.

In South Africa the respected Bureau for Economic Research at Stellenbosch University publishes the Consumer Confidence Index, which you can obtain from their website. The survey has been done since the 1970s. It provides reliable insights into the general population’s thoughts about their own economic well-being.

It’s concerning to note SA consumer confidence dropped substantially from December 2012 to March 2013  and is currently at a nine-year low point. This might not bode well for our stock markets, unless things change to make South Africans feel more positive about their financial futures.

I think there is some merit for sophisticated investors to monitor consumer confidence. But only as one of a few key indicators. However, I would not rely on this as an absolute guide to our stock market’s long-term performance. Markets move so quickly  it’s impossible to invest successfully by anticipating what people are going to feel or how they are going to spend in the short-term (periods shorter than two years).

Most of us don’t have the time to research and monitor these indicators properly. It’s better to focus on buying the index, or quality companies that can adapt to all economic growth conditions. You should always ensure your overall portfolio of investments is sufficiently diversified to survive all market conditions.

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Woodstock for capitalists

Warren Buffet’s Woodstock for capitalists

Woodstock for capitalistsWoodstock for capitalists is what Warren Buffett calls the annual chat he and partner Charlie Munger have with Berkshire Hathaway shareholders. It’s astounding to think 35 000 people went to Omaha in the US recently to listen to 82-year-old Buffett and 89-year-old Munger. More so when you consider these two guys have been partners for 54 years in the fifth biggest company in the world: Berkshire Hathaway, which is purely an investment company. The pair answered questions for six hours, ranging from the state of the world economy, to investment strategies, to advice for business success.

It’s impossible to sum up a six-hour Woodstock for capitalists session in a few pages. Instead I’ll try to highlight a few of their main points to show the logic of these two investment icons. To present this summary in a sensible way, I’ve divided the discussion into themes and looked at selected key points under each. Note that this is in no way a complete summary, and I have put it together by combining several sources.

What went down at Woodstock for capitalists

State of the US economy

The US economy has been in a worse position than it is today, for example, following WWII, after which it recovered well and grew for decades. “We’ve encountered far worse problems than we face now,” says the pair. “This is not our toughest hour.

If the US economy manages to increase its rate of growth, most of the current problems will solve themselves. Buffett says the problem will then fade into “insignificance”.

Greece and the EU

Buffett is critical of the decision to include Greece in the European Union. “It’s like putting rat poison into whipped cream,” he says. “Greece is not a responsible country.” But he says while it will take a bit longer, Europe will eventually solve its economic problems.

Decisions on the basis of macro-economic considerations

In the 50-plus years they’ve worked together, Buffett and Munger say they have never taken a decision on the basis of what is going on in the economy, or what the economic forecasts are. If you say you know what’s going to happen, then you haven’t don’t your homework, you’re simply uninformed and haven’t done enough research. At Woodstock for capitalists they explained: “If you’re not confused, you don’t understand things very well.”

Investment decisions

If you’re not in control of your emotions, you shouldn’t be managing your own investments. Investment decisions must be made on rational grounds, not from a behavioural or emotional departure point.

“We’ve always tried to stay sane when other people – a lot of them – go crazy. That’s a competitive advantage. When people get scared it’s very hard to deal with them. People get fearful en masse. When we see falling prices we see opportunity.” They also emphasise: “You can’t afford to go with the crowd on investing.”

When it comes to forecasts, their opinion is clear: “You can’t make a lot of money trying to think what is going to happen tomorrow.”

If you’re not a professional investor…

Ensure you are in a diversified portfolio. The best thing to do is to use low cost index funds. The investment industry is good at shifting capital from the investor to the fund manager. The best way to overcome that is in an index fund. The basis for this is that costs are lower and few fund managers actually manage to beat the index.

Interest-bearing investments versus shares

Buffet refers specifically to the US. but many of the principles can be applied to South Africa. He feels sorry for people who invest in interest-bearing investments. “For 90% of my life it has been better owning equities,” he explains. This means exposure to growth assets is critical for long-term growth.

Advice for successful business management

Here Buffet focuses on three points:

  • Manage cost and keep it low
  • Build your brand
  • Make sure your clients are happy

When asked a critical question about their investment in the motorcycle group Harley-Davidson, Buffet comes back to focus on branding: “Any company that gets customers to tattoo ads on their chests can’t be all that bad.”

The long-term nature of investing

Charlie Munger supports Warren Buffett when they explain long-term investment isn’t three or five years. It’s longer than that. Noteworthy is that a person aged 89 isn’t worried about what’s going to happen in the next three to five years.

On children, wills and inheritances

The pair recommend you share your will with your children when they are in their 30s. Buffett emphasises the behaviour of parents determines their children’s future It’s about them knowing about their inheritance, not the amount of the inheritance. The way parents work with money determines how their children will work with money.

Making an investment

Whether you only buy 100 shares in a business or the whole business, you must regard any investment as if you are buying the whole company. Buffet adds you must be prepared to pay a premium price for a quality business. “Paying up for an extraordinary company is not a mistake,” he emphasises. Buffet and Munger also believe in allowing businesses to manage themselves. “We’re decentralised almost to the point of abdication,” they said at Woodstock for capitalists.

Life advice

  • To young people the pair says: “Start developing your track record as early as you can, one that is a product of sound thinking.”
  • On career choice: “You have got to work where you’re tuned in. I have never been successful at something I did not like.”
  • Munger says: “The game of life is the game of everlasting learning.”
  • When it comes to expertise, they advise: “Knowing the edge of your competency is very important. If you think you know more than you do, that’s looking for trouble.”

Practicalities: What does all this mean for investors?

I believe Warren Buffet’s Woodstock for capitalists is a tune serious investors can listen to:

  1. Ensure you are not emotional when it comes to investment decisions. It’s better to consult a good financial advisor, who isn’t emotionally attached to your specific circumstances. One who will give you rational advice.
  2. Use cheap index fund solutions if you are not a professional investment manager.
  3. Don’t pay too much attention to macro-economic factors. Don’t rely on your ability to predict the future. The first step towards financial fitness is an executable, realistic plan that you can stick to. A plan like that helps you focus in uncertain times. It reminds you why you made certain decisions in the first place, if you doubt yourself. That’s why it’s preferable to enlist the help of an expert personal financial planner. It helps you focus on what you understand and make a success of it.

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Property investment

Property investment: Is it a good idea?

Property investment, good idea or not?

Property investment ins-and-outs

South Africans have a fixation on residential property investment, because we are told from a young age that we have to own a home. So, when we start work we duly buy a home and embark on our lifelong property investment adventure. As we grow older and have children, we buy a bigger house with a larger mortgage. This carries on until we retire and decide to look for a smaller home. Hopefully this time without the need for a mortgage. Many of us never stop to question whether there is a better way to use our money.

The table below shows the long-term growth of all the main asset classes in South Africa and how they have beaten inflation. The growth is calculated annually over very long periods of time. We look at long-term growth because it eliminates the distorting effect of short-term events and therefore gives us a proper perspective on these investments. Where does property investment fit in?

South African asset classes: Performance over the long-term

Asset Class Indicator Long-term annual growth above after inflation*
Shares All Share Index 7,6%
Residential Property Investment ABSA House Price Index 1,5%
Listed Property SA Listed Property 6,5%
Bonds All Bond Index 2,0%
Cash STefI Call 1,0%

 

Compiled by Galileo Capital. Sources: I-Net, Nedgroup Investments and Absa

*Updated annually since 1900 to 2012, or longest available period.

From the table above we see the best performing investment (asset class) is the share market. Over the long-term it has beaten inflation by 7.6% per year, while listed property investment is the second best performing investment. It beats inflation by 6.5% per year. Residential property investment, in contrast, has only beaten inflation by 1.5% per year since 1966 when the index was started.

The growth of residential property investment as indicated in the table does not take into account the buying and maintenance costs of property. These include transfer duties, bond registration and legal fees. In addition, you will need to pay an estate agent 3% to 7% when you decide to sell. There are also the costs of owning your home. This could average as much as 1% of the value of your home per year. This may seem high. But you need to keep up your home and garden and pay rates or levies.

While most people view a residential property as a low risk property investment, there are some risks to consider. For example, suburbs can go through cycles where the area declines, e.g. Hillbrow or Sea Point a few years ago. If this happens, you may struggle to get a reasonable selling price for a property and rental income will also decline substantially.

You also need to consider the value of the capital that you have tied up in your home that effectively does not “work” for you. An example of this would be a cash-strapped, retired person who lives in a R1 million home that is paid off. The retiree could sell the home and use the R1m to generate more income, which can partly be used to pay rent. The rent on a property investment valued at R1m can be less than the income generated by a properly diversified investment portfolio worth R1m. In addition there will be no maintenance costs. These are be for the landlord’s account. This free up even more money for the retiree.

Financially, it often makes more financial sense to invest your money in growth assets and only rent a home. However, financial considerations are only one of the factors that influence your money decisions. If you are in a sound financial position, you may derive emotional security from owning your home. This cannot be underestimated. Property investment may just be the right thing for you, under these conditions.

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Don’t get caught by unit trust fund managers

Personal financial planning onlineAs a close observer of the unit trust industry for nearly 20 years, I still struggle to find a balance between my faith in unit trusts as investments and my cynicism about unit trust fund managers. For instance, I really have to try not to laugh when I meet new product providers who promise (with a straight face) that they will provide great service and fantastic returns at low costs. All in the best interests of the investor, of course.

I think some of them actually believe their own stories. Which makes it even harder for me to keep a straight face, because we all know that their first priority is to generate profits for themselves. Here are some examples of how these product providers deal with unsuspecting retail investors.

Funds doing badly? Launch some new ones!

In a recent report by Morningstar Fund Research (2012: Annual Global Flows Report) I was surprised to see that more than 80% of all new money invested in unit trusts in 2012 went into funds that have been in existence for less than three years. This was for all new investments into all unit trusts around the world. I was surprised, because more than 80% of the world’s money is invested in funds that are older than three years. So they have a measurable track record.

Why have new funds attracted so much new money? I believe the answer is simple. Older funds went through the 2008 financial crisis, which severely dented their investment track records. Unscrupulous product providers know that retail investors place heavy emphasis on recent past performance. They therefore simply launched new funds in 2009 and 2010. These new funds benefitted from the market’s inevitable recovery after the crash, giving them a great starting track record. Unsuspecting investors can easily be convinced these new funds are being managed by a new generation of genius fund managers. This is why they attracted most of the new investments in 2012.

The financial crisis is certainly not the only cause for fund managers to launch new funds. If one sector of the market starts to perform particularly well, they will often launch a new fund with a catchy name to take advantage of this trend. One SA fund manager launched a fund based on “40 cutting edge companies” selected by a magazine. This was done to take advantage of the tech bubble formed from 1997 to 2000. The fund was launched in September 1999, six months before the IT sector peaked.

Nearly 13 years later the NASDAQ index (the one to watch for all things tech related) is still more than 30% below the levels seen at the peak in 2000. There are more examples of this behaviour. Have you noticed how few small company/emerging company funds still exist in SA? There used to be many of these funds, when small caps were the flavour of the month.

Fees

Not long ago I had a meeting with one of SA’s large unit trust fund managers. They told me clients who invested via their parent company will pay significantly higher fees than my clients, if I decided to recommend their products. The reason for clients of the parent company to pay higher fees? To protect margins of the parent company. This will be good for my clients. But once again thousands of investors are paying more than they should, simply to keep profits high in difficult markets. I am not surprised the SA Government wants to regulate fees in the savings and investment industry.

Another favourite trick for fund managers is to charge performance fees. This is such a fabulous concept. Managers earn money when their investors earn money. Why is this a problem? Because most fund managers charge annual fees in addition to their performance fees. In my view, you should either earn a performance fee or an annual fee. Certainly not both. This seems like a one-sided bet that enables fund managers to earn money irrespective of their performance. I think investors should be charged a fair fee for good performance. Nothing more.

There are some good unit trust fund managers

Before you think all unit trust managers should be placed in Purgatory, along with bankers in Britain and America, I should tell you that there are some good fund managers. Sadly in South Africa most of the great ones are getting a bit older and less focused on managing money. This means you cannot simply rely on the old favourites anymore.

To help, here are some pointers for choosing good funds:

• Cost: Try to invest in funds that have the lowest cost in their category. Avoid performance fees where possible.

• If you are investing in actively managed funds, invest in owner-managed funds. Or ensure the fund managers have a large portion of their personal wealth invested in the fund. This tends to focus the mind.

• Give a preference to focussed investment companies rather than insurance company unit trusts. There are some great unit trust fund managers who work for insurance companies. But they are in the minority.

• Track record is important. I like funds that have been in existence for 10 years or longer. Unless the funds are indexed, in which case their track record is irrelevant. A fund that is older than 10 years, beating its benchmark, is probably going to repeat this performance again.

• Are they consistent in applying their investment philosophy and do you understand it?

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Uncertainty and volatility must not scare you

Uncertainty and volatility can seem scary… don’t let this worry you

Uncertainty and volatility can seem scaryThe devaluation of the rand. Labour disputes in the mining and agricultural sectors. Concerns about our economic future. These issues all unsettle investors. The fact that the stock market performed well in 2012 is amplifying the fear. Investors worry the market cannot continue going up for longer. Should you be worrying about uncertainty and volatility too? What should really worry you; uncertainty, volatility or inflation?

Volatility is not risk

I always get grumpy when I read marketing material from fund managers. They brag about the low volatility of their funds as if this means their funds are somehow less risky than their competitors’. It’s hogwash to equate uncertainty and volatility to risk. Especially if you are a private person who needs to make smart, long-term investment decisions. If you want to generate real capital growth, pray for uncertainty and volatility. Investments with no uncertainty and volatility are either very low risk and stand little chance of beating inflation, or these are Ponzi schemes.

Uncertainty and volatility give opportunity

Where would you rather invest your money today, in platinum miners or the listed property sector? I’m sure many people prefer listed property. The returns have been great (especially last year). There is a good chance these companies will generate income and profit in the next few years.

What about platinum? The unions seem hell-bent on destroying their source of employment in a lethal game of chicken to get higher wages for a reducing number of employees. Some platinum miners are even being publicly targeted by Government. This is never a good sign for investors. However, if forced to allocate money to only one specific sector today, I would consider platinum miners and not listed property. There is good value in these miners. They have no international competition, so they have a natural monopoly. The uncertainty and volatility facing the sector is precisely what creates the investment opportunity.

Manage uncertainty and volatility, don’t avoid it

Most international markets, including SA, have performed well recently. Uncertainty and volatility has reduced and most equity investors are in a comfort zone. This is probably a good time to start worrying. Complacency coupled with equity investment is never healthy. The chance that equity markets will generate reduced performance in the years ahead is increasing. It will be difficult for most asset classes to beat inflation over the next three to five years.

Am I saying you should sell out of equities? Definitely not. I do recommend you diversify your portfolio across a range of sectors and asset classes. No-one knows if the stock markets will continue to run for the next year or three. I prefer earning dividends and not interest on cash. Optimally diversify your assets  in volatile conditions as an effective strategy.

The best investors never invest with absolute conviction. They realise the stock market will always do the unexpected in the short-term. This means they don’t bet the house on one particular strategy. Smart investors allocate some capital to one strategy. But if they’re wrong, they will have capital allocated to other strategies too. They do not take unsustainable losses. Absolute conviction with investment is always fatal to capital growth.

Inflation is your real risk

Over long periods of time the effect of inflation on your money is your real concern. If you don’t invest in productive assets such as shares and commercial property, you are guaranteeing the value destruction of your capital. This is especially true if you invest in cash and other “low risk” assets, because you want to avoid uncertainty and volatility. This is not a good strategy for long-term investing.

Productive assets are by their very nature volatile. Ideally you should focus on the income from these assets. If the income they generate increases faster than the inflation rate, the volatile nature of the capital invested is not relevant. It’s one of the reasons why Warren Buffett avoids IT companies. He cannot predict their income in the next 10 years. Therefore he allocates his capital elsewhere.

If the markets take a beating in the next year or two, I will probably increase my allocation to shares beyond my normal targeted percentage. But I will always maintain some asset class diversification. Just in case.

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Is the JSE on the road to nowhere?

JSEThe one question I’m asked most often is: “Where is the JSE going next?”. The short answer is I have no idea and nor does anyone else. However, we can use history to provide some guidelines. More specifically, we can use long-term valuations of the JSE to give us our best indication of what to expect in the medium term.

Price/Earnings ratios are instructive

The index level of the JSE All Share Index is a largely meaningless number. In essence it shows the direction and speed at which all share prices are changing on a daily basis. Whether the index is at a level of 22 000 or 40 000 is not really meaningful to long-term investors. What is relevant is how quickly the index level changes over a period of time. For example, if the index drops from 40 000 to 30 000 over a period of six months, long-term investors should start getting interested because they might find bargains.

If the JSE All Share Index is trading close to all time highs, should we infer that the whole stock market is expensive? I don’t think so. Instead, I prefer to look at the price/earnings (PE) ratio of the market to determine when the JSE is starting to look pricey.

The PE ratio of the market tells us how many years of future profits will be required to pay for the price of the market today. The long-term average PE ratio of the market is 14, which means it will take 14 years’ future profits to pay for the market at today’s prices. The graph below shows us the PE ratio of the market from 1998 to 31 January 2013. The solid black line is the long-term PE of 14 and the two dotted lines (above and below the solid line), indicate when the PE has moved significantly above or below this average.

JSE PE Graph 1998 to 2012

JSE PE Graph 1998 to 2012

It is only when the market value moves above or below these dotted lines that I start to worry about the future direction of the JSE. If the PE rises above the top dotted line, it means the JSE is starting to become expensive. Therefore it is more likely to fall over the medium term than it is to rise. For investors it is a time to be particularly cautious with your money and perhaps consider taking some profits, especially if you are over-invested in shares. At current levels, the All Share Index is near 40 000. But the PE ratio is still below 16, which means it is not expensive.

This does not mean I think the market is cheap, far from it. I believe the market is cheap when the PE drops below 12. At present, some sectors of our market are very expensive and should be treated with caution. Most retailers and international companies are very expensive. New investments into these sectors should be made with great caution. Other sectors of our market are offering good value though. This is why the PE of the whole market is not too high.

Adrian Saville from Cannon Asset Managers points to commodity and domestic industrial firms that have been overlooked by international investors as sectors offering good value. Sectors that are currently in the news for all the wrong reasons, e.g. platinum miners, are offering great value.

We need to remember the PE ratio is an average. Real problems can be hidden by averages. Just like the man who was an average temperature, because he had his head in a fire and his feet in ice. I feel you should treat this market with caution. But there is still value to be found for patient investors.

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Optimists win

Will it surprise you to know wealthy people are generally happy optimists? Probably not. In fact, most of us probably believe affluent people are happier because they are wealthy. But most of us will be wrong. Those who have achieved a measure of success in their lives have generally been optimistic and happy over their entire lives. This is also true for achievers in the fields of business, investing and sport. Those of us who live at the tip of Africa in a turbulent country can learn from these achievers.

Happy people make more money

Happy peopleA recent blog post on The Wall Street Journal site (It pays to be happy, 4 January 2013) quotes new research that finds people who are consistently happy with their lives typically earn more than unhappy people. Happy people earn an average of R32 000 per year more than the average. More worryingly, those who are “profoundly unhappy” earn 30% less than the average. It proves the point that there is a link between wealth and happiness. But it seems the path to wealth starts by being happy. Unhappy people are less likely to prosper in their careers and therefore are also less likely to be wealthy. It’s interesting that people who are generally happy from the age of 18 to 22 tend to be more successful later in life.

Optimists

After years of advising wealthy individuals, I have always been surprised by how much more positive my wealthier clients are than those who are of average or below-average wealth. I used to attribute their positive outlook to the fact that they had money to solve any potential problems. But as I found out more about these clients, I realised I was wrong. When I started to ask my clients about their early lives and in particular how they responded to setbacks, I was always surprised by how positive they were – even from an early age. They tend to have a natural belief in their ability and feel if they apply themselves positive results will follow. This is particularly true for entrepreneurs who started their own businesses.

When you ask these entrepreneurs what made them successful, many of them attribute their success to their perseverance. It’s highly unlikely a natural pessimist would persevere in a tough business, when things are going badly, whereas optimists would. It’s no coincidence most CEOs of large listed companies are optimistic by nature. Many of them are accused of being cheerleaders who always focus on the positive, without much regard for the problems facing their companies. To some extent this is a valid criticism, but one needs to understand these CEOs do not view problems in the same light as pessimists.

Investing: Try being an optimistic realist

In my experience successful investors (meaning people who have done well over decades), are almost universally optimists at heart. However, they are not unrealistic or irrational in their expectations. When I meet new people and we discuss investments, I try to get an understanding of the person’s outlook on life.

Natural pessimists are often calm in the midst of an economic meltdown because they were expecting it. However, when the market is doing well, they are usually concerned about the next crash. This might seem like a sensible attitude to money (it is), but pessimists usually have limited wealth in their later years.

The cause is simple. As they have always been “sure” the markets will crash they have tended to under-invest over their lifetimes. This decision has inevitably cost them many opportunities.

Personally it’s my 2013 goal to approach investing and business with a realistic, but optimistic view.

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Investment advice for 2013

How to manage your investments and why predictions are a waste of time…

2013 200x300Every year I get asked to make a range of predictions including: what will the rand do, how will the JSE perform, will the residential property market recover and what will happen to the overseas markets?

Without fail, I try to explain that any prediction – irrespective of who makes it – is largely worthless. After I have explained why, some people look at me with a quizzical expression and promptly ask me to ‘guess anyway.’ If we look at what happened in 2012 as an example – hopefully we can see why investment predictions are a waste of time.

Best performing assets in 2012

According to the Economist magazine, the best performing asset class in the world in 2012 was Greek government bonds. These returned more than 80% for the year. Portuguese government bonds were a close second. I cannot recall many investment gurus predicting this. More to the point, you would be hard-pressed to find many globally diversified unit trusts that had a sizable allocation to either of these asset classes.

I am not critical of the fund managers who did not allocate 20% of their portfolios to Greek and Portuguese bonds; it would have seemed reckless at the time. However I believe it proves the point that you cannot formulate a proper investment strategy based on predictions. You will either be horribly wrong or miss out on the spectacular performers.

In terms of stock markets, it has been widely reported that the Venezuelan Stock Market rose by more than 300% for 2012 (not sure why the Economist missed this) whilst Turkey and Nigeria’s markets returned nearly 60%. Even Greece’s stock market outperformed South Africa’s with a return of 32%. I am sure that none of these sectors would have been on your Top 5 Best Ideas list for 2012.

How to manage your shares in 2013?

At current levels, the PE ratio of the JSE is 15 which means it is now slightly above long-term average value. The market is not very expensive yet, we have seen PE’s of 20 in the past. There are still pockets of value – resources and construction in particular – but one needs to be cautious about some of the other sectors including property, retail, industrials and financials.

I think valuations should play a crucial role in any new investment decisions for 2013 – even more than they normally do. If you have new capital to invest in the JSE, you should seriously consider phasing your money into the market over the next few months.

If you are a stock picker, aim for sectors of the market that are trading at or below their long-term average PE’s. The retail sector is near its highest valuations and cannot offer great value to investors at this stage. However if I were a long-term investor with exposure to retail shares, I would not sell all my shares at this time. I would rather be reducing my exposure so that retail forms a smaller part of my portfolio – below your long-term ideal allocation.

It is important to ensure that you are not absolute in your investment decisions. So, if the retail sector continues to boom for the next three years, you should still be able derive some benefit from the boom. However if it collapses in June you will still be in a good position if you have already taken some good profits in January and allocated them elsewhere.

Try to remember that more than 50% of your total equity return comes from re-investing your dividends over time. If you are out of the stock market completely, you are not earning dividends therefore you are limiting your potential returns in the long-term.

It is also important to watch the profits (earnings) and especially the dividends paid by the larger listed companies. If profits and dividends increase more than their share prices increase, the valuation of these companies will decline. This is obviously an ideal scenario and I am not convinced that this will unfold (especially for the retail sector) but it is not impossible.

To index investors

This is one of those times in the market when active stock pickers will be arguing that you are crazy to invest in the index when it is breaching all time highs on a regular basis. As an index fan, I think this argument has limited merit. There are great indexed investments that are still worth consideration. Personally, I like the ETF’s that limit your exposure to sector bubbles. For example equally weighted ETF’s and fundamental indices are worth consideration, especially if you phase your purchase into the index over time.

At all times, make sure that you focus on the cost of your investment, the lowest cost investments inevitably provide the best growth over longer periods of time. This is particularly true of ETF’s.

I am not normally a fan of offshore equity investments because I think your returns (when adjusted back to rand values) are muted. However the valuations of international markets are still low and do provide some diversification benefit to SA investors, especially if our market reaches PE’s of 18 to 20.

Although I am a massive fan of the listed property sector, I am very concerned about valuations. I would be very cautious with this sector.

In summary, try to maintain a balanced investment portfolio through this year. If you have firm views on the direction of the market, try to ensure that some of your investments will still do well even if you are wrong. This means having a diversified portfolio of shares and other asset classes.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.