Why the JSE is ‘crashing upwards’

There’s a well-worn phrase that goes: what’s important is time in the market, rather than timing the market.

Tell that to the savvy punters who piled in at the JSE’s lows this year. For those brave enough to buy in the midst of a viciously sharp sell-off, the returns since have been spectacular.

Sasol? The gain from its low of R21.88 to its present R170 is 676%. Prosus has rallied about 59% from its worst of R891 a share. Redefine, another comeback story, has more than doubled. Overall, the JSE’s all share index is up almost 43% since thudding to 37,963 points on March 19.

The JSE’s V-shaped recovery mirrors that of global markets and culminated in a frenzied rally last week.

Keith McLachlan, portfolio manager at Alpha Wealth, describes Wednesday’s unexpected market shift as the "market crashing upwards". He says the world has been underweight risk for some months since the onset of lockdowns to curtail the Covid-19 global pandemic. "We saw an unwinding of that risk-off position, and by just going neutral, investors would have already started a bounce in the market."

McLachlan says that with many governments in developed economies "printing money", international investors would need to look beyond placing money in bonds with negative yields. "Consequently, emerging markets enjoyed a marked outperformance last week. In SA, small caps and cyclical stocks outperformed defensive stocks."

McLachlan stresses that the JSE started March as a "cheap" market. "Outside the big global stocks like Naspers and British American Tobacco, the rest of our market had crashed, and then got beaten down further by Covid-19."

McLachlan believes the successful court challenge to the validity of certain aspects of the lockdown has also reinforced investor perceptions that SA was still a constitutional democracy rather than a totalitarian state. This may explain why shares like Sun International and Tsogo Sun enjoyed a few days of truly eye-popping gains.

"These companies were at the epicentre of the Covid-19 quakes — huge fixed costs, geared balance sheets and a business model that works with customers being in close proximity to each other. Share prices were slaughtered. If lockdown eases sooner rather than later, casinos will reopen — albeit with added complexities in operating. But gamblers will start coming back."

The problem, for some, is that the stock market is behaving like one giant casino at the moment, too.

It’s not as if the news has suddenly improved, either. America has 40-million more unemployed people since its Covid-related lockdowns began two months ago. Germany’s industrial production shrank a truly unprecedented 25% for the year to April, and SA’s economy is likely to contract by anything up to 10% this year.

So why the frenzied rush back into stocks now?

MitonOptimal director Joanne Baynham says that while the initial rally made sense, the past two weeks seem to have been led by a squeeze of short-sellers. In other words, those who are betting that the market will fall have been caught out, and have had to buy stocks to cover their positions.

The number of puts and calls on the S&P 500 are illuminating, says Baynham.

"Most people are now buying calls, but when everyone thinks the market is going to keep going up it tends to do the opposite."

Just before markets crashed in February, "no-one" was buying protection: "They were all buying call options," says Baynham.

That changed during the market rout, when traders bought protection — put options — "because they were nervous, and then they had to cover their shorts".

Now, she says: "Nobody wants protection — and when nobody wants protection you have to say to yourself: wait a minute, this looks scary, because now everyone is on the same trade."

Why that is may be what some traders are calling the TINA trade: there is no alternative.

While the S&P 500 is trading at a forward p:e of 24 — hardly a bargain — a huge amount of cheap money is being pumped into world markets by central banks in an effort to support their Covid-struck economies.

Says Baynham, that means "you can’t buy bonds because interest rates are zero or negative in some economies; you can’t put your money in the bank because there’s no yield on that, so where do you put your money? If you’re trying to preserve your wealth you need to put it in companies that hopefully will grow."

Back home, McLachlan says it’s difficult to interpret last week’s rally as a signal for longer-term shifts on the JSE.

"It remains a difficult market to model. There is still much uncertainty and a huge number of variables. I’m not sure the rally will be sustained. But there were good reasons for so many JSE stocks to get cheaper."

McLachlan believes investors need to consider whether the world has become "safer" or "riskier".

"At the moment there still is a lot of risk that can’t be quantified."

RECM & Calibre CEO Piet Viljoen says the market might well be priced right after last week’s rally. "I can’t see huge upside in the short term, and on balance perhaps there is a lot more downside risk."

Viljoen acknowledges that some companies will battle to recover from the fallout from the pandemic. "[There are] those who believe Covid-19 is much worse than the flu and will carry on for much longer than expected. Well, [if that’s the case] there is tremendous downside."

Viljoen suggests investors will scour emerging markets for opportunities, especially among deep-value and small-cap counters. "In the end, I believe, not much will have changed. People will want to go to concerts and restaurants. These habits have not been broken."

Peter Brooke, head of MacroSolutions at Old Mutual Investment Group, argues that real returns from equities will outpace cash in the next five years. But he cautions: "The truth is that in the short term we don’t know how long this rally will last as there’s so much uncertainty."

He points out that equity typically beats cash by 7% a year, as suggested by analysis of rolling five-year relative returns between cash and equity in SA and on a real-return basis. Brooke says that over the past five years the annualised return has been the opposite, with cash beating equity by nearly 8%.

"This has been the third-longest and second-worst period of underperformance. The difference between this period and the worst period is that then cash yields were over 18% and now they are at an extraordinary 4%. So I don’t know what will happen in the short term, but I do know that in the medium term cash is no longer the place to be."

Brooke says some perspective is needed for last week’s exuberant share price movements on the JSE.

"You need to remember that some stocks had moved down from 100 to 10, so a jump to 20 meant doubling your money [from those lows]. In these circumstances, when a share is pricing off bankruptcy, that is enough to give you these spectacular share price movements."

Simply put, he says, "some share prices fell too far and now they are rebounding. In the long run our equity assets are still relatively cheap."

Brooke says small caps over two to three years could offer attractive returns. "But, like the tail of a dog, these will be the last to move with SA in recession."

Des Mayers, research analyst at Afrifocus Securities, says he has seldom seen moves on the JSE as dramatic as last week’s rally. "Investors seem to have got carried away. Perhaps some punters felt they were being left behind, and there was a fear of missing out?"

Mayers says that though the local market was oversold and due for a recovery, there could be an argument that now the market has been overbought.

"The headwinds facing many local companies certainly have not gone away. I’d be inclined to take some profit off the table at this point."