The JSE and emerging equity markets (as measured by the MSCI EM Index) have moved sideways this year. However, in something that is consistent with the now very well established pattern, the two markets indices have moved closely together day to day and month to month. Furthermore the rand, confirming another well established relationship, has continued to move closely in line with the emerging market Index.
Our model of the rand/US dollar (which includes only the MSCI EM Index as its explanation) indicates that fair value for the rand/US dollar on 12 July (given the level of the EM Index) was R6.90 compared to a closing value that day of R6.85. The fit of this model run with daily data since 1 January 2009 is extraordinarily good.
The strength of the association between the value of the MSCI EM and the JSE is explained only in small part by the fact that JSE listed shares constitute 8% of the EM Index itself and therefore attract the interest of emerging market (EM) fund managers. The relationship is more fundamentally explained by the fact that the stream of JSE All Share Index earnings per share, in US dollars, approximates very closely those of the earnings per share generated by the EM universe itself. Thus the values attached to these expected streams of earnings, by global portfolio managers, are highly comparable.
Investec Securities has created its own large market cap EM Index of about 190 individual EM companies and aggregated their earnings per share to derive both an Index called the IBICEMI and its associated Index earnings per share. As may be seen below, the IBICEMI tracks the benchmark MSCI EM Index very closely and may be considered fully representative of benchmark earnings per share.
It may also be seen how closely JSE earnings per share and EM earnings per share have been related over the years. Both earnings series demonstrated extraordinarily rapid growth in earnings measured in US dollar through the boom years of 2002-2007 before the onset of the global financial crisis in 2008. Moreover EM and JSE earnings survived the crisis in much better shape than the S&P 500 and earnings per share now exceed their pre-crisis peak levels in US dollars. The JSE Index in US dollars is now above its pre crisis peak values while the MSCI EM has still to reach pre crisis levels. This re-rating of the JSE relative to the EM ( values rising ahead of earnings ) may be seen below with the JSE trading at a 14.85 times reported earnings and the IBICEMI EM Index trading at a lower 11.21 times trailing earnings.
This rerating of the JSE may be explained by the respective earnings cycles. JSE earnings per share, while following a similar path, have grown significantly faster over the past 12 months than EM earnings represented by their large caps. JSE earnings per share measured in US dollars grew by about 46% in the 12 months to June 2011 while EM earnings growth was a less robust 26% over the same period. Clearly the relatively greater dependence of the JSE on Resource companies and their earnings has served the JSE very well as metal and commodity prices moved ahead of their year ago levels.
It can be confidently predicted that the values attached to Emerging Markets and the JSE will continue to be strongly influenced by earnings reported and expected. It can also be predicted, though perhaps somewhat less confidently, that the foreign exchange value of the rand will continue to be determined in large measure by the state of emerging equity markets. The JSE, the EM equity Indexes and the rand can be confidently predicted to remain highly responsive to the outlook for the global economy, to which emerging market economies contribute most of the growth.
To view the graphs and tables referred to in the article, see Daily Ideas in the Daily View: Daily View 15 July 2011: The JSE, rand and emerging markets: Following the same path