Economic overview July 2014: The disconnect between the economy and JSE company earnings

South African companies’ profits growth has waned. Using net operating surplus (gross operating surplus adjusted for consumption of fixed capital), calculated from South Africa’s national accounts data, as a proxy, shows the advance in total companies’ profits (financial plus non-financial companies) weakened markedly in recent years, following  a temporary bounce in the immediate aftermath of the “Great Recession”. Indeed, in 2013, profit growth was the weakest since 1998. 

Weakening net operating surplus growth



Source: SA Reserve Bank data, Sanlam Investments calculations

At the same time, the share of profits in the GDP has declined. The reason for this decrease is to be found in buoyant worker compensation growth.  Even though company tax and net interest payments have been significantly lower relative to the GDP in the post-recession environment, the share of worker compensation in total income has increased materially.  

But, the weak earnings growth reflected in the national accounts data for the total economy contrasts with the firmer, albeit more volatile, aggregate earnings momentum of companies listed on the Johannesburg Stock Exchange (JSE) in recent years. For example the earnings of the JSE ALSI (All Share Index) advanced 14.7% in the year to June 2014, despite the weak performance of the economy

Numerous factors may explain this discrepancy. To start with, the national accounts data include state-owned enterprises. Further, an increasing share of JSE listed companies’ earnings reflects operations outside the borders of South Africa. Also, arguably, small businesses that are not listed on the stock exchange may lack the pricing power of larger, listed companies.

Since the end of the “Great Recession” the picture for both earnings and total return for the small-capitalisation sector of the JSE has been especially buoyant. During the recession earnings of small-cap companies fell sharply relative to earnings for the total JSE, but recovered strongly from 2010. This partly reflects the rationalisation of operations that supported profits amongst small cap companies.

These earnings did lose some momentum from late 2013 into the early months of 2014, which is in keeping with the outright contraction in total real GDP growth in 1Q14, but have not receded to the extent seen for the entire economy as reflected in the national accounts data.

Small-cap earnings relative to all share earnings

(12 month moving average)


Source: I Net, Sanlam Investments

We should recognise the economy has been buffeted recently by one-off factors such as the platinum strike. But, the underlying momentum in real GDP growth appears to be firmer than the current data suggest, albeit modest at around 2%.

Moreover, following a decidedly weak first quarter of 2014, global real GDP growth appears to be gathering momentum, which, in time, should lend support to the domestic economy. 

That said, even though real economic activity is expected to fare relatively better in 2H14, available data are hardly consistent with strong growth. Although we cannot predict the future, one worrying development is the current softness in the South African Reserve Bank’s leading indicator for real economic activity, which suggests that the economy is unlikely to gain  robust  momentum anytime soon.

Ultimately, it is difficult to believe the earnings momentum of companies listed on the JSE can be completely divorced from the performance of the South African economy indefinitely – especially as regards the small-capitalisation stocks. Their  prospects remain closely aligned with the final domestic demand, which advanced by a mere 1.9% annualised in Q1 2014, including a tepid increase in final  consumption expenditure by households of 1.8% annualised and fixed investment spending growth of just 2.6% annualised.

And with the SA Reserve Bank indicating real interest rates may need to increase (at some point), it seems we will need to keep the hatches battened down for the foreseeable future.


The content in this article was provided by Sanlam – a diversified financial services group, headquartered in South Africa, operating across a number of selected global markets.

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