Julius Caesar divided Gaul into three parts. To better understand the JSE (if not to conquer it) we would divide it into four parts: SA economy plays, global plays, resource companies and in an important category of its own, Naspers, that is a play on global information technology.
The first of these are the banks, retailers, some of the listed property counters and many of the small and mid-cap, which perform distinctly better when the rand strengthens, inflation and interest rates come down and spending by households and firms gather momentum. When the rand weakens and inflation and interest rates move higher, they perform poorly. They depend on the SA economy for sustenance.
The second part consists of the global consumer and property plays listed on the JSE. Their (foreign currency) earnings depend on the prevailing state of the global economy. They may have their primary listing and jurisdiction elsewhere, with a relatively small proportion of their shares held by South Africans. British American Tobacco and Richemont fall into this category. Their share prices are determined by investors offshore. Their US dollar or sterling share prices are then translated back into the rand equivalents on the JSE, at prevailing rates of exchange. Their rand values go up and down as the rand weakens or strengthens, for any given dollar value of their shares.
But their dollar value may also be changing at the same time. The better their expected performance (in dollars) the more valuable they become in dollars too, to be translated almost simultaneously into rand values (and vice versa). Higher dollar values for such stocks may well overcome rand strength and lower dollar values may even drag down their rand values even if the rand weakens at the same time. They may not in fact then act as a rand hedge at all.
When rand weakness or strength has its origins in SA political developments, the global consumer and property plays will act as a hedge against the SA-specific forces that can weaken or strengthen the rand. They then perform best in rands when rand weakness, for SA reasons, accompanies the good global growth that supports their dollar values. Their rand values will then rise for both reasons: a weaker rand and rising US dollar valuations. However when the rand strengthens as it did recently for SA reasons, the opposite may happen. Their rand values can decline. Thus they are thus better regarded as SA rather than rand hedges.
In the figure below we show how an equally weighted basket of 18 SA economy plays dramatically outperformed a basket of 13 equally weighted global plays (excluding Naspers) after January 2017 and until recently. The SA plays were benefitting from a strong rand, strong not only against the US dollar, but also against other emerging market currencies, for largely SA-specific reasons linked with the demise of the Zuma regime. The global plays, for partly the same SA-specific reasons, were moving strongly in the opposite direction. It should be noted that this included Steinhoff, with an equal weight in the basket of global plays, which lost almost all of its value for company specific reasons. This is always a danger to any portfolio and highlights the case for diversification.
Thus the JSE as a whole – subject to these opposite forces with about equal weights in the All Share Index, but then helped by the gains made by Naspers and resource companies – has gained about 14% since January 2017.
Which brings attention to the third part of the JSE: resource companies. Most of their revenue is earned on world markets in US dollars. Some of their production is carrried out in SA and in rands. A weak rand is helpful to their revenues and may even help widen their operating profit margins, when rand costs lag behind rand revenues in response to a weaker rand. But a weaker rand and weaker emerging market currencies may well be associated with weaker global growth and lower metal prices.
In these circumstances, as followed the end of the super commodity cycle in 2011 and lasted until mid 2016, the weaker rand could not make up for the lower US dollar values attached to resource companies worldwide. JSE-listed resource companies were not rand hedges: their rand values declined with the weaker rand. They are plays on the metal price cycle – not on the rand. However they will perform best – as will the global consumer plays – when the rand is weak for SA reasons and when global commodity prices are holding up.
The fourth part of the JSE is Naspers, with its large holding in Tencent, an extraordinarily successful Chinese technology company. The rand value of Naspers tracks the value of its Tencent shares enough to have made it the largest company listed on the JSE. It now accounts for about 20% of the JSE, from a mere 1.3% weight in 2009. Without Naspers the JSE as a whole would be worth no more today than in 2014. The JSE All Share Index has become a play on Naspers, though the additional investment and acquisition activity expected of Naspers as well as expected head office expenses have made Naspers less valuable than its stake in Tencent and its other valuable parts.
Naspers is itself a play on Tencent and Tencent is in part a play (a high beta play) on global technology. The recent weakness in Naspers and Tencent can be explained by declines in the values attached to global tech companies. On a day-to-day basis the direct link between the movements in the S&P IT Index and of Naspers and Tencent shares has become very obvious.
And so most companies listed on the JSE will do outstandingly well for investors when faced with a combination of the surprises of rand strength and strength in the global economy, associated with improvements in underlying metal prices that will add to the US dollar and rand values of the global and resource plays. That rand strength may take off some of the gloss off the rand value of share portfolios will be of little concern to SA rand investors and even less interest to foreign investors on the JSE. And the JSE will do even better should Tencent and global technology continue to surprise investors with their results. A further boost to Naspers shareholders would come should it be able to convince the market about the quality of its own ambitious investment programme.
The potential upside and the potential dangers should it not turn out so well for the rand, the global economy and IT call for active investors. The risks to investors on the JSE are too concentrated to justify a passive approach to the JSE as a whole. 10 May 2018