A dislocation between economic realities and market views from investment professionals?

Adrian Clayton of Alphen Asset Management writes that most of us accept that as far as size, importance and directional influence goes, the JSE is equivalent to a flea on a kangaroo's tail, being whiplashed furiously as it cavorts through the undulating outback. Simply put, we are at the mercy of what is transpiring on the global financial arena!

But this is more relevant with respect to short term sentiment which drives markets in general. Over the long-term, however, our market's returns will be closely linked to corporate profitability and it is here where matters get tricky.

As we do at this time of the year, I attended yet another management lunch yesterday, hosted by one of the large international stock brokers and the top brass of one of the big four banks in SA.

The message I took home was certainly not reflective of a stock market creeping its way back to levels last seen during the heydays of 2007/2008. In fact, this particular management team, who, in line with the other banks, produced a set of results that could hardly be described as inspiring, were decidedly cautious on the future, they spoke about a world much closer aligned to what Bill Gross termed a while back, the 'New Normal'. 

This is a world very different to the one we have become accustomed to. It is a space filled with inactivity as far as credit extension and business exuberance is concerned, one which follows a relatively low road of slow, benign growth and poor economic traction. A key theme from the lunch was the high state of indebtedness in South Africa and how different this cycle has been relative to those in the past. Bank management make the point that the negative turn in South Africa's employment cycle, together with the high levels of indebtedness going into the downturn, have proven a lethal concoction.The now unemployed but indebted obviously have no means to repay.

They emphasised the sticky nature of indebtedness this time round considering the extent to which interest rates have already been reduced in SA. It also struck me that banks seem to have been relatively lenient on underperforming mortgages in the hope that these would improve as the property cycle turns. Whilst not pushing the point, reading between the lines, I got the impression that there exists a real risk that any interest rate rises would lead to banks needing to house billions of rands of repossessed properties.  These would ultimately come onto the market at severely depressed levels. A summary of the mood of the lunch was that it was sombre, aimed at negating high expectations, indicating a management team's desire to communicate economic realities that seem to be lost to the investing community.

Ironically, just before the bank lunch, we met with an investment strategist, a well respected individual within the local market. At PSG Alphen, we hold this person in high regard, however, predictably and consistent with his industry colleagues, his message was anything but dire. JSE profits, which we all know are going to be strong this year, he views as powering ahead for the following year too. Whilst he is slightly cautious on profitability in the financial sector, he is incredibly sanguine with respect to resource earnings.

This is the most intriguing part of earnings predictions for me.  It seems that resource management teams and analysts alike have all become intoxicated with a positive outlook for resource profits. Ask them to reconcile such zealous predictions with a world that has slowed down to a point where it relies on a financial Zimmer frame handed out by central banks, proves tricky. Of course the central theme is China and fast growing emerging markets. Although this might ultimately prove perfectly accurate, one cannot help but question the strategy of betting so aggressively on one growth engine whilst the balance of the world's motors are incapable of even sparking at present.  That said, I think it is important to mention that from a bottom-up perspective, we are presently finding certain resource shares that are not factoring in hefty future profits, relatively attractive.

Markets are humbling, in that betting against a major trend can be very painful and generally the market is relatively efficient and thus often right.  But, clearly, as we have seen often in the past few years, this is not always the case and bouts of extreme optimism and pessimism do occur leading to disequilibrium and subsequent reversions. I might be wrong, but currently it feels that we heading that way again.

So in summary, one senses a dislocation between economic realities at ground level and market views from investment professionals. Time will tell if this is just another case of overzealous market alchemy or if the economy will catch up with the market.

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