South African investors on the JSE will be only too well aware that it has moved mostly sideways over the past few years. The performance of the JSE in US dollars however presents a very different picture, given the strong recovery of the rand last year. The US dollar value of the JSE, the focus of foreign investors, fell away badly in 2015 and then recovered strongly in 2016. The JSE All Share Index (ALSI) is now back to its value of early 2014 and 2015 having gained nearly 20% in US dollars since January 2016 as can be seen in figure 2. The rand itself is worth about 20% more against the US dollar – compared to February 2016.
The reason for these very different outcomes, when expressed in different currencies, is obvious enough – it is the result of rand weakness in 2014 and 2015 and its significant strength in 2016-17.
Clearly the very strong rand, up 20% year on year, represents a strong head wind for the value of shares expressed when expressed in rands. Or, in other words, for a share to have provided positive rand returns over the past 12 months, would have had to have seen its US dollar value appreciate by more than the 20% gain in the rand, a very high rate of return.
Naspers, with the largest weight on the JSE of about 17%, delivered coincidentally about a 20% increase in its US dollar value since January 2016. This was satisfactory enough, but not quite enough to provide appreciation in 20% more valuable rands.
Resource companies on the JSE did much better than the average listed company, especially from mid-year. Their US dollar value has increased by about 50% since early 2016, more than enough to provide highly satisfactory rand returns, despite the stronger rand. It may be a source of some confusion to market observers that JSE Resources could do so well, despite rand strength. In other words, Resource companies did not behave as a rand hedge in 2016: in reality they performed as rand plays (companies that do especially well when the rand strengthens).
They would have enjoyed much higher operating margins had the rand been weaker – other things remaining the same – including underlying metal and mineral prices in US dollars. But the rand was strong because underlying metal and mineral prices in US dollars had risen, by more than enough to offset the pressure on operating margins that comes with a stronger rand.
Therefore it is always important to establish the sources of rand strength or weakness. Rand weakness for SA-specific risk reasons can make Resource companies or companies with largely offshore operations effective hedges against rand weakness. Their rand values will go up as the rand weakens because they are selling into world markets where business continues as usual and so earn more rands doing so. The opposite influences are at work on SA economy companies when the rand weakens, especially on the rand and US dollar value of companies with an important element of imported components and inventories. The weaker rand not only crimps operating margins; it means higher prices and less disposable income. More inflation also is likely to bring higher borrowing costs in its wake, further depressing the demand of households and firms. Rand strength for SA-specific reasons will have the opposite effect, all other things equal, including the state of global markets, especially commodity markets. But as we have seen in 2016, other things do not necessarily remain the same for global growth reasons. Resource companies can benefit from higher commodity prices, in US dollars, and from higher metal prices in rands – even when the rand appreciates.
The increased global demand for commodities and for the shares of the companies that produce them not only increased their US dollar values. They also increased the demand for the rand and other emerging market currencies and equities generally that have a strong representation from resource companies. In the figures below we show the rand has moved in line with other emerging market currencies- represented by eleven such currencies all equally weighted in our basket. It is also shown how the rand in 2016-2017 has been stronger than its emerging market peers have been against the strong US dollar, with its recovery from a relatively weak position in late 2015.
Of particular interest is how strongly the USD/ZAR rate has been connected recently to emerging market equities. (In turn the JSE in US dollars is as usual strongly connected to the average emerging market equity as we have shown above). The rand is more than ever an emerging market equity currency. It can be assumed (Zuma permitting) that the rand will continue to move in line with them (see figure 7 below).
