S&P – ZA Economist

The quarterly earnings reporting season is now almost behind us. As we show below the deep trough in earnings in 2009, coinciding with the global recession, is now more than a year behind us. JSE All Share earnings per share since May 2009 (smoothed) have grown by nearly 40% with the growth in Resource Sector earnings leading the other sectors by a very large margin. Financial Sector earnings reported to date are barely ahead of where they were a year ago while JSE Resource Sector earnings have grown by nearly 80% with Industrial Sector earnings up by about 20% on a year before.

The Resource counters have clearly benefited from the recovery in commodity prices that has contributed also to the strength of the rand. The industrial companies have gained from the recovery in the global economy and the recovery in the SA economy where growth is pacing that of global growth. Industrial companies, especially the domestic retailers and distributors of goods and services with high import content, benefit form rand strength. The banks might ordinarily have been expected to benefit from rand strength and the lower interest rates that follow lower inflation led by rand strength. However the demands for bank credit have stalled at only marginally positive growth rates. Until house prices and demands for mortgage loans pick up momentum the growth in bank revenues will remain subdued.

We compare reported JSE earnings, so called trailing earnings, with what we describe as normalised earnings. Normalised earnings are estimated using a 10 year rolling time trend. Trailing earnings are catching up with normalised earnings. If the past is a guide to the future then there would appear to be considerable scope for further earnings upside. The underlying trend in earnings growth also suggests as much. If the underlying trend in All Share earnings is extrapolated, the prediction is growth in All Share earnings of 30%, to be reported in 12 months’ time, led by growth in JSE Resource earnings of over 60%. Clearly such a time series forecast would be vitiated by any sharp reversal in commodity prices.

These underlying trends may be regarded as encouraging of higher valuations on the JSE. As we also show the JSE All Share price to trailing earnings is just under 16 times while the price to normalised earnings ratio is of the order of a below average 14 times. Clearly for the market to move ahead normalised earnings will have to materialise and most important world markets will have to be supportive.

Earnings and dividends from companies listed on the developed equity markets have also recovered strongly from crisis depressed levels of 2009. S&P reported earnings per share in the first quarter of 2011 have recovered to over US$81 compared to the barely US$7 of mid 2009. S&P earnings and dividends per share are now nearly back to their record pre financial crisis record levels.

It makes no sense to attempt to normalise S&P earnings given their extraordinary recent collapse. Consensus forecasts expect US dollar 100 of S&P earnings per share by year end, to be reported in Q1 2012. When we normalise S&P dividends that were much less severely damaged we find that reported dividends are still trailing well behind normalised dividends.

The S&P at 1331 has recovered strongly and outpaced Emerging markets over the past six months as we had suggested it would. When we calculate a dividend discount model for the S&P, discounting trailing dividends by long term interest rates going back to 1980, we find the S&P to be 24% undervalued for trailing dividends and 32% undervalued for normalised dividends. We therefore continue to be of the view that the least demandingly valued of the equity markets is the S&P 500.

To view the graphs and tables referred to in the article, see Daily Ideas in todays Daily View: Daily View 31 May: With reporting season behind us, some room for comfort in current valuations

March 2011, by month end, proved a very satisfactory month for foreign investors in the JSE. The SA component of the benchmark MSCI Emerging Market Index ( that excludes the dual listed companies on the JSE), performed very well and in line with the emerging markets benchmark, as we show below.

To view the graphs and tables referred to in the article, see Daily Ideas in todays Daily View:Daily View 4 April: Equity market earnings: A volatile month ends well (especially for offshore investors)

The total return performance of the JSE and of the MSCI SA in March 2011 was assisted by the strength in the rand against the US dollar and also by the relative strength in JSE reported earnings, especially when converted into US dollars. JSE reported earnings in US dollars are now growing significantly faster than those reported by the EM stocks included in our Investec Big Cap emerging market index.

Such faster growth is implicit in the currently superior rating enjoyed by the JSE. As we show below the JSE is trading at 15.3 times trailing earnings and our EM Index at a less demanding 12.3 times.

The S&P 500 by contrast is now trading at 17 times reported earnings. The annual growth in these S&P earnings is now 50% but this is growth off a highly depressed level of 2009 and 2010 – when S&P earnings collapsed from a peak level of over US$80 in late 2007 to less than US$10 per share by mid 2009, as a result of the global financial crisis.

Thus it will take until the end of the year to make proper sense of the underlying growth in reported S&P earnings; these are currently US$77 per share and are expected to approach US$100 within 12 months. The issue of how best to normalise S&P earnings will remain a very difficult one for many years, given the collapse of 2009.

Investec Securities calculates normalised earnings for the JSE. Its calculation (as shown below) suggests that the price to normalised JSE earnings ratio is below the trailing multiple. This indicates that if earnings continue to normalise, the price earnings multiple for the JSE may recede further. The bottom up forecasts of JSE earnings one year ahead indicate expected growth in JSE earnings in rands of close to 30% to be reported over the next 12 months.

The earnings outlook for the JSE appears to us as strongly supportive of current valuations. Our view remains however that the most obvious value in equity markets is suggested by the S&P rather than emerging markets, of which the JSE is an integral part. Should S&P earnings proceed as expected and approximate US$100 in 12 months, the multiple adjusted for expected rather than trailing earnings falls to about 13 times. This is well below long term averages for the S&P.

However any strength in the S&P that becomes realised as investors grow more confident about the earnings outlook is unlikely to mean weakness in emerging markets, but only perhaps a relative underperformance. Should the growth in S&P earnings materialise as expected, this will indicate that the US economy is in good enough health to withstand higher interest rates.

The usual tug of war between better earnings and higher interest rates can be expected to resume within the next 12 months. However it is only expected to restrain in part any rerating of the S&P and the advance of the S&P itself. We regard good 12 month S&P returns of the order of 10-12% as a distinct possibility. Brian Kantor