Understanding the last 9 months

So we wake up one morning and it is October 1, 2009. We pour ourselves a cup of coffee and contemplate the Share market. Year to date your investment in shares is up 15.81%, your investment in cash is up 6.5% and inflation is at about 6.4%.

Now if you are like me you think about the future and ask yourself "what now?"

This is what flashes through my mind at that moment of asking the question:

Cash is killing me! (return wise that is). I earn 7% pre tax (4.2% after tax) and inflation is at 6.4%. That is okay for short term liquidity but what about the longer term, say 5 years from now.

Do I invest in shares at these levels? This I will only do if the price I pay for them now is still good value. A good way to determine the value of a share is to look at its Price/Earnings ratio (PE).

We have experienced what they call a "crash" in the share markets in 2008. An easy way to see how severe this "crash" was is to look at what happened to the PE ratio of the market and compare it to the long term average.

The 20 year average PE for the JSE All Share index in South Africa is 14. If the current PE ratio is below this average, we can say that the market offers good value and vice versa. In March 2009 the PE stood at 8 (market very cheap), currently it is at 13.5 and rising.

The increase from 8 to 13.5 is reflected in the 30% + rise in the share market from March. The question is, "can this continue?" The answer lies in the historic behaviour of the market.

2 Things happen after a crash. We saw this in 1961, 71, 76, 82, 88, 91, 98 and 2003.

First there is a Re-Rating of the share market. This is not a recovery based on a fundamental improvement in the shares like an increased earnings growth, but rather a reversion to mean. The 20 year PE mean is 14; it stood at 8 so it wants to go back to 14!

This reversion is lightning fast and unannounced. This time it happened at the beginning of March 2009 and is over. If you weren't in the market you lost this re-rating rally.

Secondly you get the fundamental recovery which is mainly driven by the earnings growth of companies. Investors will not continue buying a share from these levels until they are satisfied that the company will grow its earnings from current levels. We saw a 30% year on year growth for 4 years after 2003. The important thing to remember is that the PE ratio of the share does not increase substantially because the earnings growth matches the increase in the share price so the company with a 10 PE might increase its PE to 11 but the share might go up 20%.

After all this I can give you a short answer: The JSE All Share is still good value but the next 20% growth will take much longer than 6 months to materialise and will be driven by the recovery of company earnings rather than re-rating or sentiment.

Money or the Box?

I have taken some flak from readers regarding my insensitivity towards people who have no money to invest; made all the mistakes I wrote about and have no hope of earning the big bucks ever!

I have some GOOD NEWS!!!

You still have a remote chance of one of the following happening:

• Marry rich
• Win the Lotto
• Inherit from somebody you don't know

One of these can happen! But in the meantime, let me give you some good advice which we can call "Money or the Box".

This is a very simple game where I give you a choice between choosing the money or choosing the box where:

Money = Salary

Box = Lumpsum Cash

If you choose the money I will give you R10 000pm before tax for the next 25 years which will increase with inflation.

If you choose the box I will give you R1.5mil now.

NOW YOU CHOOSE!

To see which one is better, I will assume the following to make us compare apples with apples:

• You earn no other income thus your tax on the money will be R1 000pm. This leaves you with R9000pm spending money.
• Your actual expenses are R7 000pm in both instances.
• The monthly savings from the "money" as well as the R1.5mil lumpsum can be invested with a growth of 2.5% over and above the inflation rate.

Result:

If you choose the money, you will be able to survive for 36 years. So if you are 40 now, the money will be gone at age 76.

If you choose the R1.5mil cash, the money will be gone in 23 years (age 63 if you are 40 now).

Conclusion:

Your ability to generate an income is far more important than being a millionaire today.

The Good, the Bad and the Ugly!

Believe it or not, you get investing personality types! I am one of 4 brothers, raised by the same Mother and Father and we all invest differently. Now if you can admit that you have a problem, you are 50% towards solving it!

3 of the 4 investment personalities need help. The 4th one doesn't because he/she is consumed by understanding investing. Let me take you through the 4 personalities and help you solve your problem.

The Fearful person:
This is the person that cannot and will not go into the proverbial investment water! If you ask him today where his money is he will say "cash". If you ask him in 10 years he will say "cash". Then you tell him that inflation is 7% and after tax he gets 5% on cash, losing 2% of his investment value each year and he will say "but shares are too risky". This is the person that can never retire because for every Rand he earns, the tax man takes 40% and inflation the rest. This person has to work an hour to earn a $. He will never have what we call "passive income". Money being earned on investments while he is sleeping or drinking coffee.

The Cure for the fearful person: Go see 5 independent financial advisers. If they all tell you to invest some of your savings in shares and they give you the same reason, believe them! I mean really! If a lawyer tells me that I will go to jail if I steal a car, I believe him.

The Reckless person:
Now this dude is the opposite of the fearful one. This guy is bullet proof, balls to the wall, nobody can tell him anything. His mania is usually driven by greed. He will make and lose millions during his life and the end result is usually not in his favour. He is lucky, not wise and you should never get sucked into his plans.

The cure: Go see an independent financial advisor. Let him calculate how much money you need to be financially independent for the rest of your life and give him that amount to invest and manage for you. You can take the rest of the bucks and do whatever gives you a rush.

The Ignorant person:
This is somebody that doesn't care about money. For them it is all about life and living. Money has no meaning and at best it is a means to an end. If they do not stumble upon a "money spinner" passion they will not compromise their beliefs just to make some cash. These people are also very generous and will often give and not receive. They will also believe the rubbish clever sales people tell them and get burnt badly. Because money is not important to them, they need very little. The problem is that because of their disinterest in money, they miss even the most basic opportunities to invest wisely, getting money that they can give away if they like.

The cure: Just listen to somebody you trust and that knows about investments. Let that person advise you on not necessarily making money but rather just not wasting money.

The Calculated investor: This person eats, sleeps, drinks and talks investments. He will not always be right but because he understands investments, he will be conservative and bold over time, winning 51% of the time and losing 49% of the time. He will get to a point in his life where he generates more money from investments (passive income) than from working. He understands two things very well and they are, patience and respect for money.

His advantage: He knows that investing is a science. No single investment can always be the right one and no two people should invest in the same manner.

Life is a balancing game, so too investments.

New investment options.

There are 2 things I can tell you that you might not know about when it comes to investment products and that might be to your benefit.

The First one is a product from Discovery Invest and you might have heard the ads on radio. It is all about them giving you up to 26% more than the amount you invest and guaranteeing a 6% growth on that portion.

The cool thing is that if you lost money in the crash last year, you can get it back by investing with them. So these are the basic facts:

• Invest say R1 000 000 in any of the unit trust funds they have on their list.


• Get R260 000 from them invested at 6%. (26% of amount invested)

What do you have to do to deserve this?

• You have to take out a life policy from them. The higher the monthly premium, the bigger the sweetener up to the 26%.

Bottom Line: If you need life cover, consider this opportunity, if not, not the best investment but also not bad. I will provide more details if requested.

The Second product is called the Investec Money Market iSelect fund. If you want to leave your money in cash, this fund will give you on average a 0.25% higher yield than the normal Investec Money Market.

Fund Name and Yield
Cadiz Money Market 9.09
Gryphon Money Market 8.88

Investec B (iSelect)* 8.79
Allan Gray 8.57
Investec Money Market R* 8.49
Metlife 8.43
Old Mutual 8.32
Standard 8.22
Nedbank 8.21
Coronation 8.13
Prudential 8.11
Symmetry Money Market 8.10
RMB 8.09
Absa 7.96
PSG 7.96
Sanlam 7.61
Glacier Money Market 7.11

The higher yield is due to the way the iSelect fund is priced. If you pay tax on interest at a rate of 40%, you can also benefit by buying this fund in a sinking fund wrapper and paying only 30% tax on interest.

6 months down...,6 to go!!

And with hindsight we can see that the JSE All Share has hit the SA Cash investor for a huge 6!

Early in April I sat down and selected the 10 shares on the JSE main board that were trading at the highest discount to their Net Asset Value. In simple terms, I selected shares that were washed down the toilet by me, you and all the other people in the world!

Now you must understand, this required very little intellect. All you have to do is open the list of companies trading on the JSE, go to the column that says NAV, go to the column that says Current price and choose 10 with the biggest difference.

The only spice you have to add is ensuring that the companies are reputable. This is the list I chose:

1. Grindrod
2. Investec
3. Metropolitan
4. Old Mutual
5. Pallinghurst
6. Peregrine
7. PSG
8. Reinet
9. Remgro
10. Stefanutti

And the result is.......19.5% capital return if I sell them today and that is not all!!! They will pay me an annual tax free dividend of 5.325%.

Now if that doesn't get you excited, compare it to a 1.875% taxable return cash would have given you over the same period.

Why do I tell you this? Because it was so damn nice to be able to play the lotto with such good odds!

Moving On...

What now? Well...the odds are slightly less favourable but let's consider the following:

• Shares on the JSE are still trading 29% below their highs in 2008.
• The US shares are way behind in the recovery.
• Interest rates have come down 4.5%.
• World sentiment and company earnings are stabilizing overseas.

These bullets all point toward more growth in share prices from current levels.

But consider the following: A number of companies in South Africa will report very weak earnings during 2009 which will turn sentiment negative every time the press reports it. This will create volatile markets.

Conclusion:

If you still have money to invest for 5 years +, buy the SATRIX RAFI share and forget about it for now, and even better, if you haven't got any international exposure, NOW is a good time to get the exposure with the Rand trading at R8/1$. Buy an international Unit trust like Allan Gray Orbis International Equity Fund of Funds or Sim Global Best Ideas Fund.

Quote From Warren Buffett:

'the argument is made that there are just too many question marks about the near term future; wouldn't it be better to wait until things clear up a bit and maintain cash reserves until current uncertainties are resolved?

Before reaching for that crutch, face up to two very unpleasant facts: the future is never clear and you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values".

Warren Buffet, Forbes interview, 6 August 1979

Please tell me...!!

....you have purchased shares with the cash you don't want to use for the near term! Since my last piece the JSE all share has moved as high as 22 700 and now stands on 22 015. That is a 10% increase in a couple of weeks.

If you are still in cash, you are earning 1% less than when we last touched base!

The other thing to take note of is the Rand exchange against the US$(R10.00 to R8.30). If you want to invest offshore or buy $ you should consider doing so now.

Something that a lot of investors forget about is their offshore investments. A lot of people have large $ cash portfolios offshore earning almost no interest due to the rates coming down. With the international equity markets also 30% cheaper than 18 months ago, you should consider switching the cash into shares if you deem the cash to be a longer term investment!

How to invest in shares without incurring high costs or admin hassles? Try the range of SATRIX investments. You can get all the info on www.Satrix.co.za

Something that you should start thinking about for the future is the possibility of inflation going up due to all the cash made available by international governments. Now, if you stay in cash, you will be slaughtered! if you are invested in shared you will be protected and if you want to have a lower risk investment you could look at an inflation linked bond like the newly launched product from RMB called "INFLATION-X".

Stay in Cash or move to Shares?

If you are not asking yourself this question yet, here are some reasons why you should:

Cash (prime overdraft rate): 15.5% (June 2008) now 13% Down 16%

The Reserve Bank changed the frequency of its meetings to monthly (excl. July) and cut the repo by 100bps in March. A further 100bps cut is expected in April which should give even more relief for the indebted. We would expect another 250bps-300bps in interest cuts which should provide a strong stimulus for equities.

Although cash provide a positive return on investment, the trend is down and you might end up earning only 9.5% on your cash at the end of the year.

SA Equities (JSE All Share): 33 000 (May 2008) now 20 000 Down 39%

Markets remain volatile and a further correction in the market cannot be ruled out. However, the second half of 2009 should be an improvement on the first, with equities expected to re-rate ahead of the economic recovery.

Equities went from its low of 17 770 (Nov 2008) to 20 000 currently. This is an improvement of 12.5% over 5 months which is a 30% annualised return.

Example on possible investment:

If you invest R100 000 in cash for 5 years and you end up earning 9.5% interest on average over the period (before tax), your R100 000 will grow to R157 424. This is an 11.49% annual growth.

If you invest R100 000 in shares for 5 years and you end up earning half the last 5 month average annual return (15%), your R100 000 will grow to R201 136. This is a 20.23% annual growth.

Conclusion

One should look at the markets objectively and intelligently. An investor should understand that investing in cash could be just as risky as investing in shares. Too much cash has an opportunity cost (earning less than one could earn elsewhere), and too much shares could have an absolute cost (losing money).

Stick to an investment philosophy of:

· Hold enough cash to cover expenses for the next 5 years.
· Invest the rest in shares, bonds and listed property.