For the last four years the JSE has set a special holiday puzzle for investors: Is the domestic equity market over- or undervalued?

This year, STANLIB, the investment 'home' of 400 000 unit trust-holders, provides some expert tips on how to crack the valuation conundrum.

"Since April 2003, the JSE has recorded phenomenal gains,” explains retail investing director Paul Hansen. “Every year-end since then, equity winners have been unsure whether to take money off the table or remain fully committed.

"In the recent past, many experts got part of the puzzle right - they backed equities as the best-performing asset class. But they have regularly advised investors to moderate their expectations only for the JSE to outperform all forecasts.

"This year (2007) has been no exception, with All Share Index gains of 20 percent."

The experts are again scratching their heads over how much value can be found.

STANLIB says numerous measures can be applied. For example:

1. Compare over 20 years the institutional cash yield on three-month Negotiable Certificates of Deposit (NCD) to the All Share Index earnings yield (share earnings divided by share price).

   Prime is up 33 percent since June 2006 (from 10.5 percent to 14.5 percent) while three-month NCDs are up 54 percent (from 7.1 percent in mid-2006 to 11 percent in November 2007). The JSE has soared, so the earnings yield should be low (the price/earnings ratio or PE inverts the earnings yield). One might assume the stock market would look expensive versus cash, but it's not. Over 20 years, the average three-month NCD rate has been 5.3 percent higher than the All Share earnings yield. Today it is only 4.3 percent higher. So the market looks undervalued relative to cash.

2. Compare the 10-year government bond yield to the All Share Index earnings yield - a comparison that may be less meaningful at present.

   The JSE looks undervalued against the 8.35 percent bond yield, but bond yields are abnormally low as government is cash-flush and does not need to issue many bonds. The three-month cash yield is 11 percent, but the 10-year bond yields only 8.35 percent. This is so unusual this classic comparison has little current validity.

3. Compare historical PEs.

   The current All Share Index PE is 14.9 (down on 17.3 at the end 2006). This is mostly because of higher interest rates. As the cost of money rises, PEs go down and vice versa. The average PE since 1994 has been 14.5, so we are slightly above average, but many analysts anticipate good earnings growth of 17 percent one year out and interest rates could be near their peak. Furthermore, long-term infrastructure investment is strong and consumer prospects should improve as rates ease.

   Therefore, our current PE ratio of 14.9 could indicate an undervalued stock market despite long-term averages. After all, economic growth and company earnings are way above average.

   The prognosis is also influenced by the relationship between rates and earnings. Remember, when interest rates decline, PE rises. The equation is: PE ratio x earnings per share (EPS) = share price.

   So if EPS is rising and the PE is rising, your share price rises strongly!

All in all, STANLIB is looking for 18 percent growth in the JSE All Share Index in 2008. The forecast assumes that corporate earnings will grow by 17 percent as expected, that interest rates soon peak, that commodities remain strong and global growth remains on track.

"Markets can always spring a surprise,” says Hansen. “That's why this end-of-year puzzle is so fascinating."

Sapa