When it comes to market performance, SA is not alone

South African investors can be forgiven for feeling a little sorry for themselves at the moment. Performance on the JSE has been pretty dire, with the All Share index down 0.6% for the year to date, and unlikely to improve any time soon.

Making matters worse, while our market is in the red, US indices seem to be going up and up, exacerbating our feeling that the rest of the world is moving ahead while we are sliding backwards.

What is interesting, however, is that South Africa is not alone when it comes to negative market returns. US-based Yardeni Research has compiled an interesting series of charts using MSCI data that show that pretty much the only place to have been this year was in the US, invested in the S&P 500.

This chart, the first of 22 slides that detail global stock market performance, shows that when it comes to global indices, the US was a clear outperformer.

The following table is a summary of the research, but the actual research can be found here.

MSCI Index performance for the year to October 3	Performance in USD	Performance in local currency
World indices
United States	9.5%	9.5%
Emerging markets	-10.7%	-5.8%
EMU (European Economic and Monetary Union)	-5.7%	-1.9%
Japan	-1.3%	0%
UK	-6.2%	-2.4%
Emerging markets
Asia	-10.4%	-7.2%
Latin America	-4.7%	3.3%
Europe
France	0.1%	4.1%
Germany	-10.1%	-6.6%
Greece	-30.1%	-27.3%
Italy	-9.7%	-6%
Brics and others
Brazil	-7%	7.9%
China	-12.9%	-12.6%
India	-12.3%	0.6%
Russia	5.3%	17.9%
South Africa	-29.9%	-14.1%
Indonesia	-21.4%	-12.7%
Australia	-7.6%	1%

The US is the only market to have moved strongly upwards this year on the back of a strong economy and earnings growth momentum. Given the strength of the USD in relation to other currencies on the back of rising yields in the US, it is perhaps unsurprising that markets underperformed the US when converted to dollars. But even in local currencies, the only markets that standout are Brazil, Russia, Sweden, and Taiwan.

This trend is not new but has been playing out over the last five years, says Kyle Wales, co-head of global equity boutique Old Mutual Titan. In this time the S&P 500 has delivered compound annual growth of 13% versus Europe’s 3.7% and 1.9% for emerging markets (EMs).

While the world has been experiencing a synchronised global recovery since 2016, it is evident that the stronger economies are starting to pull ahead, says Johan Gouws, head of institutional consulting at Sasfin Wealth. “Emerging economies, specifically China and India, have been driving global growth and are expected to continue doing so. This year sees the US pulling ahead of Europe and Asia, at about 2.9%, according to the IMF.”

However, he notes that economic growth is not necessarily correlated to stock market growth, as is evidenced by JSE returns over the last two decades:

A closer examination of the Yardeni charts shows that the sell-off in many markets began in May or June this year. This suggests that there is more than just economics at play. Certainly US President Donald Trump’s policies are boosting US economic growth; however, his escalating trade war with China is depressing economies in the rest of the world, adds Gouws. “This is putting pressure on the rest of the world to come to terms with Trump’s demands for fairer and more bilateral trade. The risk is that Trump’s policies may be causing harm to emerging markets, which are export-oriented.”

The US as a whole is looking toppish valuation-wise, adds Wales. “The only time in the past that it has been more expensive – whether one looks at it on a P/E basis, or market cap, or the US GDP versus the Russell 3000 index [which provides exposure to the entire US stock market] – was in 2001, just before tech bubble burst.”

There are several things that are distorting the picture, he says. One is the strength of the US currency. “We look at currency through the lens of purchasing power parity and many of the emerging market currencies are looking cheap. This tends to reverse over time.”

Another is what he calls the ‘micro picture’ where a few companies, notably tech stocks like Apple, Microsoft, Amazon and Google are distorting the performance of the S&P 500. “In the long term, valuations will reassert as the dominant driver of returns.” 

This means, he adds, that emerging market assets are undervalued. “I would certainly have a bigger EM exposure right now.”

Fund manager BlackRock also notes that the market appears to have too narrow a breadth – a fragile state when a small group of stocks contributes to the lion’s share of market returns, buoying the broader index. The top 10 companies have accounted for 53% of the total return of the S&P 500 Index so far this year, versus 30% in 2017.

However, BlackRock chief investment strategist Richard Turnill says that if one looks deeper it is evident that the median stock’s EPS (earnings per share) growth stands at 21%. 

“We are not seeing signs of extremes in the market. Absolute stock valuations globally are within their historic ranges. In the US, valuations are above their long-term average, but not excessive beyond a small group of stocks.”

He adds: “The 10 stocks with the best price performance in the S&P 500 have a median price-to earnings ratio of 48 this year on a forward 12-month basis, while the median stock in the index has a multiple of just 17.2.” This means that most stocks are marching in the same direction, while outperformance of market leaders has been persistent – driven by strong fundamentals.

However, the sell-off in emerging markets is also overdone, Turnill believes. “A lack of breadth in declining markets also has little predictive power, in our view. The recent sell-off in EM equities was led by a relatively narrow group of stocks, with the 10 bottom performers in the MSCI EM Index accounting for nearly 40% of the hit. A single stock was responsible for 14% of the decline. Yet we see EM stocks supported by attractive valuations and robust earnings.

“We do not see narrowing equity market leadership as a warning sign of the market’s health. More important than the number of stocks leading the market is the quality of the fundamentals driving the market.

“Rather the steady global expansion underpins our preference for equities over bonds, and robust 2018 earnings estimates make the US our favoured region.”

Unfortunately, the rising tide may not lift all markets and the JSE could be in for a longer period of sideways growth. “As we can see from the red and green chart above, the market is not necessarily correlated to economic performance,” says Gouws. “However, five years of flat economic growth will catch up with you eventually. The JSE is an environment of great caution at the moment with current political developments, the mini-budget, rating reviews and elections in 2019 ahead of us.

“With so many moving parts right now – including rising US rates, trade wars, Brexit, emerging market sentiment, Italian politics, local political and fiscal concerns, I think the key takeaway is the importance of portfolio diversification.”