As of yesterday’s close the JSE Top40 Index is 7.38% down from the record high of 47,143.71 registered on the 3 of July, 63 trading days ago. The Top40 is also back at levels last seen the 12th of May. Sentiment has dropped quite a bit and together with the relative expensiveness of the market, raises the question if the last two weeks’ price action merely the start of a bigger market downturn?
As a result of the drop in market sentiment our timing tool has dipped into the lower hemisphere of the table and at first sight is frighteningly close to the dark red quadrants that predict a zero percent probability for an upmarket over the subsequent three months.
Further investigation has shown that the timing toll rarely enters the “dark side” of the investment universe from the top, meaning a drop in sentiment while the market is sitting on high PEs, like what we are currently seeing. Instead, the “dark side” tends to be approached from the left hand side when the market is seemingly cheap and sentiment is low. The question may arise, how can a cheap and downward trending market get more expensive? This happens when earnings (the denominator) decreases and the multiple increases as a result. We are of the opinion that this is not what we are seeing at the moment. The risk is leaning more towards downward revisions in forecasts as opposed to actual declines in earnings.
The current trend seen in our timing model coincides closely with previous trends witnessed in June/July 2004 and August 2010, with general weakness evident but the market ultimately regaining traction.
Fundamentally we remain of the view that the global business cycle is entering the “late expansion phase” which entails rising interest rates, economic momentum and an upturn in inflation (economic indicators) while the bond curve flattens with the short end catching up to the longer end, equities perform well and volatility increases. Thus the recent spurt in volatility is in our view text book and we will continue to see more severe corrections in an upward trending market.
Technically the Top40 is also starting to look attractive, with the 14 day RSI dipping below 30 and implying oversold conditions, while the index is trading around its 200 day moving average (43,929.90) and a longer term 23.6% Fibonacci retracement level (43,800.32).
Although we do not advise trying to catch a falling knife, we do recommend buying into the strength once the market finds a footing. With our eyes on the late expansion phase we put an increased weighting on momentum factors such as price change and earnings revisions. Our preferred stocks in the JSE All Share universe are:
TELKOM SA SOC LT
ASTRAL FOODS LTD
BRAIT SE
SIBANYE GOLD LTD
TONGAAT HULETT
PEREGRINE HOLD
MR PRICE GROUP
SAPPI LTD
NETCARE LTD
FIRSTRAND LTD
INVESTEC LTD
RMI HOLDINGS
AFRIMAT LTD
INVESTEC PLC
MEDICLINIC INT
SANLAM LTD