South Africa: Market Trends Not That Reliable

MARKET sentiment is not as reliable a short-term barometer on the market as many commentators on investment suggest.

The favourite test of its accuracy is, we're told, the future correlation of share prices and earnings growth. If the market trend changes, this, we're told, means much the same trend is about to happen to companies' investment fundamentals.

I'm not convinced. I have noted over many years that a bull trend ends when shares are overbought and vice versa. This is true not only of shares. For example, in the residential property market, house prices kept rising as long as demand met supply. When it became evident that supply was exceeding demand (in stock market parlance the market had become overbought) prices began to stick and then to fall.

The house market is in a bear trend now - but it didn't become a bear trend ahead of the interest rate crunch. House price levels resisted higher interest rates for quite some time.

It is interesting to note that the line chart of the JSE electronics and electrical index has had, over the past two years or so, almost the same shape as that of the JSE real estate index.

Following the barometer thesis, if the current weakness in the JSE real estate sector is warning of a bear market in commercial and industrial property, then we should expect significant falls in earnings in the constituent companies in the electronics and industrial index.

I can just accept that supply of office, retail and factory space can outpace, or already have outpaced, demand because of the economic slowdown. I find it much more difficult to believe that the demand for infrastructural growth is suddenly going to slow and drastically curb earnings growth of Altech and Reunert, as the "barometer" suggests.

My experience of the stock market is that a change in its trend doesn't necessarily forecast good or bad news. Its trend does, however, tell us when good or bad news has been digested and that the process of digestion can often be uncomfortable. And the digestive process pushes the trend too far and too fast.

The market is, after all, a crowd. Let's look at a recent example of crowd behaviour - the trend in Sasol's share price trend. We all know that, for obvious reasons, Sasol's share price has a correlation with the oil price. The crowd often tends to forget, however, Sasol is not only about oil . The Private Investor portfolio bought Sasol shares in December at R315,70. The oil price (Brent) was then $95 a barrel.

The oil price peaked at about $140 towards the end of last month and the earlier part of this month. Sasol's share price hit a peak of R506 in May, well before the oil price peak. As I write, oil is about $125, 10% below peak and Sasol's share price is about R400, 20% from its peak. The market either lied on Sasol's way up or is lying now.

The point is that you can't rely on market sentiment to be an early warning on future investment fundamentals, which include, of course, a lot of gambling.

Article by: Ben Temkin -