Correlation of the rand vs the FTSE/JSE All Share: What to expect

Prieur du Plessis of Plexus says that it is a well-known fact that foreign investors play a very big role in influencing the direction of the local stock market. When foreigners are net buyers of our equities, they drive up the price of the FTSE/JSE All Share Index, and vice versa.

While foreign buying in our equity market is normally accompanied by rand strength (in 2008 the rand lost 28,5% against the US dollar amid foreign selling to the tune of R54,4 billion, and in 2009 the rand gained 28,7% while foreigners were net buyers to the tune of R72,2 billion), there are periods where the rand and the FTSE/JSE All Share Index are negatively correlated (i.e. the two move in opposite directions).

A recent study by Plexus Asset Management analysing the rolling six month correlation between the rand/US dollar exchange rate and the FTSE/JSE All Share Index shows that the correlation tends to move in a cyclical manner between +1 and -1 (see accompanying graph).

When the graph is above the zero line it shows that the two are positively correlated (i.e moving in the same direction) and when the graph is below the zero line the two are negatively correlated (i.e. moving in opposite directions).

It is interesting to note that the correlation is currently at an all-time high (going back 15 years) of above 0,98. If we look at the historical trend of the graph, conventional wisdom indicates that a turnaround should be expected in the coming months, i.e. a move into negative territory.

While the rand has remained very stable against the US dollar for the year up to 30 April 2010, it has declined by over 3% since the end of April. Furthermore, although the FTSE/JSE All Share Index declined by more than 11% from 15 April 2010 to 7 June 2010 (and is still down 6% from 15 April to date), foreigners have been net buyers of our equities during the months of April, May and for June to date. And while it does appear as if the stock market is trying to extend the bounce from the current short-term oversold level, we should perhaps not be surprised if the rand experiences a devaluation at the same time.