I blame it on Neat TV, DStv's programme about tidying up your life, the end of the tax year and the realisation that, even now, New Year's resolutions still have the power to utter a faint whimper before disappearing altogether in the business of 2006.
Although it is not spring in South Africa, I have had the compulsion to clear out the clutter, pare down, simplify, tidy up and throw out the old. My share portfolio has not escaped this urge, as even there I am questioning every single holding and its right to exist at this stage of the local market's bull phase.
Anyway, something useful came of my efforts to clean up my ever-slowing laptop, which has been groaning under the disorder and muddle of long-forgotten files and programs. I came across a simple spreadsheet (source unknown) that listed the three phases of bull and bear markets.
I was instantly transported back to April 2003, when the South African market bottomed out at 7 361 after having fallen precipitously by 35 percent in the preceding 12 months. (The market recently breached 20 000.)
The spreadsheet contained a diagram that listed the following characteristics as typical of the late stage of a bear market:
- Obvious deterioration in the state of the economy;
- Widespread bad news;
- A change in investor sentiment from hope to despair;
- The public exits the market in droves;
- Fear is the main driver of investment decisions;
- Investors dump stocks; and
- Great value emerges.
Time in the market
As we approach the third anniversary of the greatest bull market in South Africa in years, let's reminisce about some evidence of the above in 2003, in the hope that we won't miss the investment opportunity the next time it comes around, and once again remind ourselves that a long-term approach works when investing in the stock market.
If you stayed in the market from April 2001 or April 2002 until today, you would still have achieved an annual return of 20 percent or 16 percent respectively. If you picked the bottom of the market perfectly (which is unlikely), your three-year annual return would have been 42 percent. If you got in the market a year after it bottomed, your two-year annual return would have been 37 percent (all returns excluding dividends). A good approach would have been to stay in the market and to have invested more of your cash as the market turned in 2003.
The above evidence highlights the advantages of having a well-structured, diversified portfolio and of avoiding emotional, knee-jerk reactions to market fluctuations.
In April 2003, there was little hope that interest rates would decline, and the prime rate was 17 percent. Do you remember the leaking of the mining charter and the impact it was expected to have on our market?
Bad news abounded. Headlines lambasted fund managers for losing pension funds billions of rands as the market plummeted.
It was easier to sell a cup of rooibos tea to a rugby fan at Newlands than to get people to invest in equity unit trusts.
During the first quarter of 2003, outflows from equity unit trust funds totalled R154 million. This compares with total net inflows into equity funds in excess of R12 billion since then, and R3 billion in the first quarter of 2005 alone.
For five months of 2003, the earnings yield on the stock market was higher than the long bond yield for the first time in 20 years. The earnings yield is the inverse of the price:earnings (p:e) ratio, so a higher earnings yield means that stocks are cheaper and vice versa.
Great value was emerging in the face of an apparently poor environment. Interest rates were about to undergo a structural shift - downwards. The market had discounted all of the bad news and more. It was time to buy.
The beginnings of a bull market display the following signs - the picture is somewhat similar to the last phase of a bear market:
- Great values - in other words, cheap investments at low p:e ratios;
- Very poor sentiment;
- Lousy economy; and
- Many reasons not to invest.
The average p:e ratio on the JSE was below nine times in April 2003.
Sentiment remained poor for a while, with headlines pointing out the poor returns that pension funds had achieved over the past year.
Conservatism gained ground when it came to investment products, with absolute return funds gaining market share. It seemed easier to find reasons to stay out of the equity market.
Phase two trends
It is now three years later. We appear to be well into the second phase of the current bull market. If that is the case, we should see the following:
- A trend of erratic market increases and setbacks;
- Slowly improving economy; and
- Improving profits.
Markets are reflections of human sentiment about the past and the future, so we cannot expect to find a perfect recipe in a 13-kilobyte spreadsheet. However, we have certainly seen more erratic behaviour from our equity market over the past year or so, with two setbacks last year and one so far this year. The economy has undoubtedly improved and company profits have perked up.
How will we know, then, that we are getting to the late stage of the bull market? Look for the following:
- Rapidly decreasing values - remember those information technology shares with p:e ratios of 100?
- The "this time is different" mentality. We have seen a little of that, with the most ebullient predictions hinting that China can carry the commodity cycle into infinity.
- Good performance by the economy - this is true in South Africa.
- Widespread public participation in the market. We have not seen this to the extent that we saw in previous bull markets, perhaps because the public is too busy with its property portfolios.
- Greed as the main driver of prices. We're not quite there yet as far as equities are concerned, and my hairdresser and dentist still spend more time on my hair and teeth than on sharing investment tips.
- The hereafter is discounted. The high exposure to equities of South Africa's large fund managers is of some concern, because this indicates that they are positive on the equity market, but at least their cash levels are also quite high.
Listings and mergers
Another trend that is evident late in the bull phase is the explosion of new listings and corporate deals. Mergers and acquisitions have taken off internationally, more so than in South Africa. For example, Arab takeovers of firms in Europe and the United States totalled US$30 billion last year.
We have not seen as many new listings in South Africa in the current bull market as in the previous one. Abroad, the picture is somewhat different. The Gulf states have seen privatisations and initial public offerings (IPOs) at bargain prices. It is not unknown for stocks to climb 500 percent on the first day's trading. Applications for new issues can be oversubscribed by up to 800 times.
The reason we have not seen this happening in South Africa could be that the requirements for listing have become more onerous (for instance, the guys professing to turn water into oil would have a tougher case this time around), and, again, property has absorbed a lot of the more speculative savings.
There are some more worrisome signs elsewhere in the world, though. In the oil-exporting states, newspapers report that police have been called in to protect banks from over-eager IPO subscribers. A Saudi woman is said to have divorced her husband for no other reason other than he had lost money in the stock market. Talk about irreconcilable differences ...
I'd say we are flirting with the final stage of the bull market, but we're probably not there yet. You may still have enough time left to consolidate your investments into a more concise, weatherproof portfolio.
At this stage of the market, you may find that some "bull market" investments have crept into your portfolio. Although these investments have done you proud, they probably don't deserve to be long-term tenants. Now is the time to clear out the clutter and make sure you have only solid, long-term investments in your portfolio.
Anet Ahern is the chief executive of Sanlam Multi-manager International.