Wednesday, January 4, 2012

My take on the JSE Top 40 Index - why I ran from stocks

I am back with yet another very bearish take on the stock markets, this time a bit closer to home, this time I am looking at the JSE Top 40 index and I am considering the possibility of a severe pull back in the market in the coming years.  

In this posting I am hoping to show that the current gains we had on the JSE since mid 2008 were merely a smoke screen, and that in fact, the Top 40 Index has already crashed when measured in value.  We just have not caught up to the idea yet. While the index has not dropped in price, what appears to be eroded is what we can purchase with our stocks.      

In my previous two postings I looked at the the US SP500 index (a technical view) and some predictions for the global economy in 2012. Both these predictions were very negative.    

This led me to investigate the matter further, a bit closer to home. I decided to run some numbers for myself.

So, with information obtained from Standard Bank Online share trading and Index Mundi, I considered the prices of 5 important commodities, in relation to the Top 40. The main question I looked at was how much value one share of the JSE Top 40 will purchase as measured in commodities.     

Put in a more simple way; how much stuff does 1 share of the Top 40 currently buy? Why is this important? Well if we cash out our stocks, it does not help us if we can buy less with the proceeds.  

Let's begin by considering the following chart of the Top 40 Index. This represents annual closing prices of the index at the end of every year since December 1995.

Click to enlarge
If you look closely, you'll see that the index closed at 26250 at point 1 in December 2007 just before the big crash of 2008.

That is our first reference point. During the crash of 2008 the index closed at 19201 points (December 2008). Since December 2008 we had a price recovery.

Now consider point 2 on the chart (our second reference point): the closing prices for December 2010 and December 2011, these are 28558 and 28487 index points respectively. Also notice the sideways movement. The index recovered and closed even higher than it was in 2007 before the crash, only 2828 points away from the all time high in 2008. 

[Note: the index reached its highest level on the 23 May 2008 at 31315 index points, from there it fell to a low of 15905 on 20 Nov 2008, this is not reflected on the year end chart). I had limited information, so I had to use closing prices. See the last technical chart for the monthly closing prices.   

So, we had a crash on 2008, recovered, and now the index is close to its all time high. But, does this tell the entire story. I don't think so.

Most savvy investors know that they have to account for inflation.  In order to make a real profit in the stock markets, you have to be able to buy more stuff than before with your proceeds or dividends, logical isn't it? Your growth must beat inflation.    

With that being said, how much commodities could we buy with 1 Share of the Top 40 in 2007-2008.

To calculate this I divided the index points of the Top 40, with the prices of commodities. That should give an indication to the Top 40's buying power per share

We'll consider maize, soybeans, crude oil, gold and coffee for this analysis. Wheat and maize underlies much of the world's food supply, so maize is up first.

Click to enlarge
The chart above seems to suggest that before the crash it, near the previous high of 08, it was possible to purchase between 25 and 20 tons of maize with one share of the Top 40. As at the end of December 2011 we could only purchase 12.77 tons with 1 share (even with the index near its previous high); amounting to about 10 tons less.


Click to enlarge
Soybeans seem to tell a similar story. Before the crash of 2008, it was possible to purchase up to 13.24 tons of soybean with one share of the Top 40. Now, near the index top, we can only buy about 8 tons of soybean; about 5 tons less.

Coffee (Robusta):

Click to enlarge
With coffee, the trend seems to be the same.  Before the crash of 2008, we could purchase about 5138 pounds of Robusta coffee with one share of the Top 40, now we can only purchase about 3237 pounds; about 1900 pound less with one share.

Crude Oil:

Before the crash of 2008, your one share of the Top 40 purchased about 57 - 58 barrels of crude oil. Now that same 1 share buys only 40 barrels; approximately 17 barrels less.

Click to enlarge
How about gold? Before the crash of 2008 you could buy about 5.5 to 5.8 oz's of gold with one share of the Top 40. Now one share buys 2.2 oz of gold.

Logically, the drop in purchasing power of the Top 40 owes to the increase in commodity prices. So we seem to have a scenario where the index went up and commodity prices went up. Does this increase seem to suggest a dilution in real purchasing power?

My wallet seems to agree. This explains, to me, why it lately felt like everything had become so much more expensive in South Africa.

We have to confront the possibility that we are experiencing a silent market crash, where the market moves sideways, or even goes up in price, but drops in value when measured in commodities.

Why is this bad?

One thing I am sure of is that the markets 'live' to find fair value. And, in order to restore value, I think only one of two options are possible; deflation of commodity prices or a drastic drop in the markets; both options are scary.

It is more than likely that the inflation of the commodity prices, we have seen, is directly related to the quantitative easing (money printing) the US has done since 2007.

Economists tell us that when too much money chases the same goods and services, we have inflation. Printed money also runs up investment prices, this I believe is reflected in the increase of the Top 40. But, printed money also dilutes the purchasing power of every rand or Dollar.

A problem may arise when more people invested in the markets realize that their stock portfolios will buy less than before.  That realization may generate a mass exodus from the markets, a run on real assets, and a subsequent market crash

(Click here to see what gold has done up to now)

Personally, I am no longer invested in the stock market. Am I missing out on opportunities? Maybe I am, no one can predict exactly what the markets will do. But based on real value the Top 40 seems to me to be declining in value, for now, I'll rather be a bear sitting in cash and metal.

I am just not willing to carry the inherent risk of stocks in a declining value scenario. Still, the markets may even go up in price this year, the question is will it go up in value?    

What to take away from this? 

  • Consider that the markets may be declining in value when measured against commodities, you may want to ask your financial advisers about this. 
  • To restore value, the markets may eventually correct/crash or, commodity prices may fall, which may suggest a decline in aggregate demand for goods and services (also bad!) 
  • It may be pertinent to investigate some ways of hedging against a potential market collapses.  
  • Remember that proper diversification should cover both stocks AND other asset classes. Often, the gold guys love gold, the stocks guys love stocks, real estate guys love real estate. However, falling in love with one asset class may prove fatal in this economy.    

As Promised earlier in the post, here  is the monthly chart of the JSE Top 40, I've included some technical analysis to the chart which I will explain in my next posting.

JSE Top 40 Index Monthly Chart, click to enlarge. 


I am not a professional financial adviser. Information presented is intended to be solely conversational and educational, please don't make investment decisions based on just one source, do your own research, and consult a registered financial adviser

While I tried my best to present accurate information and numbers in this posting, I cannot guarantee the accuracy of any information presented.     

Posted by Gerhard van Onselen (follow me on Linked In and Twitter)

No comments:

Post a Comment

Please leave your insights, comments, and suggestions in response to the posting. Balanced Life SA aspires to be helping and respectful community. Irrelevant and obscene comments will be removed by moderators.