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Contents

Executive Summary 3

1. Market Performance 6

1.1 Y2008 in Review 6

1.2 2008s Diamonds and Dogs 13

1.3 Large Cap versus Small Cap 15

2. Politics 17

2.1 Political Landscape in 2009 17

2.2 Implications to Equity 18

3. Our 2009 Themes and Implications to Equity 19

3.1 GDP Growth rate deceleration 19

3.2 Interest Rates to Fall in Synch with Growth 21

3.3 Compelling Valuations May Persist 24

3.4 Volatility May persist on Earnings Surprises 36

4. Valuation 37

4.1 JSE Valuation 37

4.2 Our 2009 Top Stock Picks 39

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Executive Summary

The JSE ALSI lost 25.7% in 2008. The Top 40 was not far behindat -25.9%. The worst loss was incurred by the Small Cap index

which shed 34.3% of its value in 2008. The sharp downward trend

in share prices that began in June 2008 lasted 5 months, with positive

returns only witnessed in November and December. The ALSI

incurred a cumulative loss of 51.6% from its May peak of 31,841.27 to

settle at 20,991.72 by end of October 2008.

Relative to our EM universe, SA was the third best performer with

a USD return of -46%. Our universe had an average return of -56%,

and SA outperformed markets such as Russia, China, Brazil and

Egypt by a wide margin. On a 10-year return basis, SA was the third

best performer in USD terms, again out-performing Russia, China,

Brazil and Egypt.

Foreigners were net sellers of the SA equities in 2008. While this

might normally account for most volume-based trading volatility,

should the global economy and liquidity conditions improve, the return

of foreign buyers may act as a catalyst for a re-rating of market

valuations;

The Small Cap sector outperformed the ALSI, Top 40 and the Mid Cap

since 2004 when indexed to CY2000. The out-performance spread is,

however, narrowing. In 2008, the Small Cap sector was the worst

decliner with a return of -34.3% (local currency). We expect the

Small Cap sector to under-perform the Large Cap sector again in

2009.

Our 2009 themes are centred on a marked deceleration in both the

economic and corporate earnings outlook. However, gross fixed

capital formation should remain positive, even though spending by the

private sector is set to slow. We expect interest rates to fall by a

cumulative value of between 250 and 275bp by the end of

CY2009. Inflation is set to fall rapidly due to the impact of lower rand

commodity prices, especially oil and food, and the re-weighting in the

inflation basket. Forecast risk to the inflationary outlook remains,

however, given the depreciating rand, sticky unit labour costs and

the precarious balance of payment position.

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We expect current compelling valuations to persist in 2009. On a

relative valuation, the JSE ALSI is trading near the historical mean of

our EM universe at 7.3x (the mean is 7.7x). South Africas historical

P/E ratio is, however, 2.2x that of Russia which is 3.5x. On a PEG

ratio basis, South Africa is the most expensive market (at a PEG

ratio of 3.5x) when compared to the BRIC countries;

We expect volatility to persist at relatively higher levels than in

previous years. While we expect volatility to continue on earnings

surprises both positive and negative we also note that historically

volatility took a period of about 2 years during phases of market

dislocations and recessions to revert to normal levels. Current volatility

is over 2x the norm of 15%;

We recommend investors to adopt a defensive bias in 2009, until

stability is reached in 2H09. Increased exposure to cyclical and

Small Cap stocks can be adopted in 2H09. Our suggested

defensive industries are food producers and cash retailers, healthcare

(including pharmaceuticals), tobacco, telecommunication and

breweries. Hence, we recommend exposure to non-cyclical

companies with the ability to grow earnings at a premium rate to the

market (i.e. MTN, Shoprite, BAT, and Tiger Brands).

Infrastructure spending will be key to economic growth in

CY2009. About R500bn worth of projects in transport and power

infrastructure and low-cost housing is expected to offset a slowing

GDP growth rate beyond 2010. Politically, it is imperative for the

government to loosen up fiscal policy in order to absorb excess labour

in the economy as well as stimulating the economy. Notwithstanding

the fact that South Africas bank balance sheets are relatively healthy,

and access to bi-lateral financial institutions such as the IMF and

World Bank remain open, we remain sceptical of the sustainability ofthe financing options given the current global credit crisis.

Should weak growth outcomes persist in 1H09, sharp interest

rate cuts should be expected in the next 6-9 months. Discretionary

retailers, banks and construction stocks will consequently be the main

beneficiaries in those conditions. Our picks in this scenario (i.e. 2H09)

include Murray and Roberts, Truworths, Richemont, Absa Group,

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Nedbank Group and PPC. Interest rate cuts will also underpin

valuations as the cost of equity will decline.

We expect a lacklustre performance by the JSE in 1H09, mainly

dragged down by resources and financial counters. On resources,

we expect waning demand to continue, and at the current rating (P/E

ratio around 9X) we do not believe our expectations are priced in yet.

Banks will be negatively impacted by relatively higher private sector

defaults. Low interest rates and lethargic growth rates of lending

books due to the impact of the economic slowdown will negatively

affect interest margins.

Our expectation of the fair value of the JSE ALSI is 24,233.91, just

about 9% from the current valuation. This provides no

fundamental value for the next 6 months.

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1. Markets Performance (CY2008)

1.1 CY2008 in Review

The year registered only five months of positive monthly returns. The

best month was February while the worst month was September.

August returns were negligible.

The year 2008 recorded a negative return. The JSE ALSI lost 25.7%.

November and December witnessed positive returns. This was largely

a result of market correction after heavy negative returns in

September and October.

Source: Bloomberg, Legae Calculations

With falling prices, the dividend yield rose to a high of 6.1% in

November from 2.9% in January. The dividend yield is currently at

4.7%, still significantly higher (23.7%) than the average dividend yield

for the year (3.8%).

We expect the dividend yield to migrate towards 3% in 1Q09, and this

happens on (1) share price rises and/or (2) dividend cuts by

companies on poor earnings. We see the latter probably happening

more than the former as we expect earnings to register muted growth

rates at best, and negative growth in general.

Monthly Average Returns

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

January

February

March

April

May

June

July

August

September

October

N

ovember

10-Dec

Average

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Comparing 2008s performance to the past 10-years performances of

the JSE indicates that 2008 is the worst year over that period. There

are only three occasions, post-1994, where the JSE posted negative

returns: 1997, 1998 (Asia-Tiger and Russian currency crisis) and 2002

(recession in America after the dot.com bubble).

The JSEs ten year average return is 15.5%, a difference of 41.2

points from the current -25.7%. To incorporate the 1997-1998 market

downturn, the average return since 1996 falls to 13.8%

Dividend Yield (%)

4.67

1

2

3

4

5

6

7

1/2/2008

2/2/2008

3/2/2008

4/2/2008

5/2/2008

6/2/2008

7/2/2008

8/2/2008

9/2/2008

10/2/2008

11/2/2008

12/2/2008

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Comparing the JSE performance to our EM universe, we note that

South Africas outperformed markets like Russia, China, Brazil, and

Egypt with a return of -46% in USD terms.


JSE Annual Returns: 1996-2008

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

1

996

1

997

1

998

1

999

2

000

2

001

2

002

2

003

2

004

2

005

2

006

2

007

2

008

Returns

Average = 13.8%

Returns of Select Emerging Markets 2008 LC

-71.3%

-70.5%

-65.4%

-53.9%

-51.2%

-46.2%

-45.8%

-41.2%

-36.1%

-25.7%

-80.0% -70.0% -60.0% -50.0% -40.0% -30.0% -20.0% -10.0% 0.0%

Russia

Romania

China

Egypt

Poland

Israel

Nigeria

Brazil

Mauritius

South Africa

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The average return of our select EM universe is -56%, giving SA

significant out performance.

We note that the rand depreciated worst against the US dollar.

Performance relative to the Russian ruble, the Chinese yuan, the

Brazilian real and the Egyptian pound was recorded at -27%, -16%,

+7%, and -23% respectively. This indicates the underlying over-

performance of the SA equities against our select EM.


Returns of Select Emerging Markets 2008 USD

-75.9%

-75.0%

-63.0%

-54.8%

-54.3%

-53.7%

-49.0%

-45.8%

-45.1%

-43.3%

-80.0% -70.0% -60.0% -50 .0% -40 .0% -30.0% -20.0% -10.0% 0.0%

Russia

Romania

China

Brazil

Nigeria

Egypt

Poland

South Africa

Israel

Mauritius

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Using the 10 year returns of our EM universe, SA outperforms markets

like Russia, China, Brazil and Egypt. In fact, SAs USD return over

the 10 years is above the average of our universe, which should

provide little upside risk if one believes in mean reversion to the

long term EM average.


It is interesting to note that when comparing 2008 returns to the 1998

market performance, Russia actually performed better in 2008 in local

currency. South Africa performed worse, with 1998 and 2008s

returns being -14.4% and -25.7% respectively in local currency.

USD Returns of Select Emerging Markets (1998-2008)

0%

50%

100%

150%

200%

250%

300%

Niger

ia

Isra

el

Sou

thAfric

a

Mauri

tiu

s

Egyp

t

Braz

il

Chin

a

Russ

ia

Roman

ia

Po

lan

d

Yearly Returns for select Emerging markets (1998-2008)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 LC 2008 USD

Brazil -30.2% 151.9% -10.7% -11.0% -17.0% 97.3% 17.8% 27.7% 32.9% 43.6% -41.2% -55%

Romania -49.6% 28.9% 15.2% 38.6% 119.8% 30.9% 101.0% 50.9% 22.2% 22.1% -70.5% -75%

Nigeria -11.9% -7.2% 54.0% 35.2% 10.7% 65.6% 15.9% 2.7% 38.7% 74.7% -45.8% -54%

Russia -79.3% 197.4% -18.2% 81.5% 38.1% 58.0% 8.3% 83.3% 70.7% 19.2% -71.3% -76%

Israel 10.8% 57.2% 4.4% -9.2% -27.3% 51.0% 22.6% 33.3% 12.5% 31.4% -46.2% -45%

Poland -0.2% 24.1% -1.3% -22.0% 3.2% 44.9% 27.9% 33.7% 41.6% 10.4% -51.2% -49%

Egypt -21.3% 42.5% -41.9% -30.3% 1 .9% 116.7% 105.3% 131.7% 10.7% 51.3% -53.9% -54%

China -6.2% 19.2% 51.7% -20.6% -17.5% 10.3% -15.4% -8.3% 130.4% 96.7% -65.4% -63%

Mauritius 15.0% -6.4% -10.5% -12.6% 17.1% 37.6% 28.8% 13.6% 49.8% 53.8% -36.1% -43%

South Africa -14.4% 66.8% -2.6% 28.1% -11.3% 12.0% 21.9% 43.0% 37.7% 16.2% -25.7% -46%

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The graph below indicates the progression of the JSE ALSI historical P/E

ratio over CY2008.


The current JSE ALSI P/E ratio indicates massive undervaluationrelative to its historical context. Expectations of steeper declines in

corporate earnings growth in 2009 would expose the fallacy of buying

SA equities exclusively on this metric. However, investors with longer

term investment horizons could progressively increase their equities

exposure from late 1H09. Our expectations of a global economic

recovery in 2H09 should provide a catalyst for a re-rating of market

valuations.

Market P/E ratio

12.28

14.94

7.65

3

5

7

9

11

13

15

17

1/2/08

2/2/08

3/2/08

4/2/08

5/2/08

6/2/08

7/2/08

8/2/08

9/2/08

10/2/08

11/2/08

12/2/08

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Source: I-Net , Legae Calculations

We note that since 2000, foreigners were net sellers of SA equities in

2002 and 2003 (R5.6bn and 0.4bn respectively). This year, foreigners

are net sellers of over R55.4bn, a colossal figure relative to the period

under review and about 2.2% of the countrys GDP.

We believe that foreigners will eventually return to the SA market a

relatively important EM asset class and member of the MSCI - should

EM risk premiums subdue. Subsequent liquidity injections will

materially improve valuations. We do not attempt to speculate as to

when foreigners may return to the SA market, but we do expect

sustainable opportunities to prevail once trading volatility subsides. It

is therefore reasonable to presume that foreigners will be net-

purchasers of SA equities by 1H10.

Foreigners were net sellers of equities in 2008 (R bn)

14.8 29.8 (0.4)49.5

117.871.7 64.2

(5.6)

(55.4)

(800)

(600)

(400)

(200)

-

200

400

600

800

2000

2001

2002

2003

2004

2005

2006

2007

2008

Purchases

Sales

Net Purchase/-Sales

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1.2 2008s Diamonds and Dogs

Below we show the best and worse performers for the year 2008.


Some of the best performers of the Top 40 are actually losers in real

terms as the year-end returns are either negative or below inflation

rate, an indication of the severity of the downward movement in share

prices in 2008.

It is crucial to note the defensive switch that has played out already

in the market. As indicated below, about 6/10 top gainers of the

ALSI are in defensive industries, mainly food retailers and

producers.

Top 40: Gainers and Losers 2008

-68%

-67%

-54%

-49%

-49%

-48%

-43%

-43%

-41%

-36%

0%

3%

10%

12%

23%

39%

-7%

-4%

-2%

-3%

-80% -60% -40% -20% 0% 20% 40% 60%

Lonmin

Old Mutual

Liberty Int Plc

Anglo Amer plc

Anglo Platinum

Mondi Ltd

Kumba

Impala Plat

SAPPI Ltd

Investec Plc

Gold Field

Pik n Pay

ABSA Group

Grow th Point

Reinet

Naspers

Remgro

Tiger Brands

Shoprite

Harmony Gold

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Notably, the majority of losers in the JSE ALSI are shares outside the

Top 40. The only Top 40 members in the bottom 10 is OML and

former Top 40 member Lonmin. Four of the top 10 gainers are,

however, members of the Top 40.

We highlight that 2008s worst performers may outperform as share

prices may recover primarily on a mean reversion basis. YTD the Top

40 members who were members of the worst 10 performers in 2008

indicated strong performance. OML has a YTD return of 19.7% and

Lonmin has already gained value by 18.5% (12.01.09)

JSE ALSI: Gainers and Losers 2008

-90.8%

-85.6%

-82.6%

-78.3%

-75.7%

-72.7%

-68.4%

-66.8%

-64.2%

-63.7%

9.7%

11.5%

12.5%

12.8%

16.3%

17.4%

20.7%

23.1%

26.3%

38.66%

-100.0% -80.0% -60.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0%

Metorex

Super Group

TWP Holdings

WeSizwe

Sentala Mining

Bell Equipment

Lonmin plc

Old Mutual Plc

Buildmax

Merafe Resource

Remgro

Tiger Brands

Mr Price Grp

Oceana Group

Convergenet HLD

Massmart HLD

New Clicks

Shoprite

Truwor th INTL

Harmony Gold

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1.3 Large Cap versus Small Cap

Source: I-Net, Legae Calculations

We are not convinced that small-caps will re-rate given the

current liquidity crisis and the expected global recession . The

wide gap between the Small Cap sector and the other three major

indices that typified the period from around 2004 to mid-2008 is

unlikely to endure in 2009. We expect smaller companies with

unsustainable debt levels and weak cash reserves to be worst hit by

the recession. We caution investors against prematurely reducing risk

premiums in this sector. Given the endemic negative bias and current

systematic weaknesses in this sector, underperformance of the Small

Cap could persevere. The Small Cap index provided the worst

performance in 2008 at -34.3%

Performance Indexed to 2000

0

1

2

3

4

5

6

7

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Top 40

Small Cap

Mid Cap

All Share

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Small Cap Sector Was the Worst Performer in 2008

-26% -26%

-22%

-34%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%All Share Top 40 Mid Cap Small Cap

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2. Politics2.1 Political Landscape in 2009

It is anticipated SA will hold national elections in early April 2009. The

landscape has become diverse, with the formation of COPE as a

breakaway opposition party from the ANC.

It is difficult to assess if there will be substantial shifts in support form

ANC into COPE. However, private institutions that carried out their

own polling indicate that support for ANC is being eroded in key

provinces such as Eastern Cape, Western Cape and Northern Cape.

COPEs gains in these regions are mainly attributed to the party

spending most of the festive season campaigning in these provinces.

We expect the ANC to win the presidential elections. Should our

expectations materialise; the ANC will have the prerogative to appoint

its presidential candidate, Mr Jacob Zuma, as the President of the

Republic. At the point of issuing this research note, the ANCs

president is campaigning under a cloud of legal battles. The NPA

appealed to have corruption charges against Mr Zuma reinstated, and

the judgement was in the NPAs favour. It is widely expected for Mr

Zuma to approach the Constitutional Court in a bid to challenge the

decision.

Most political analysts have highlighted the fact that Mr Zumas

administration will adopt a mostly leftist policy approach. The ANC

reiterated in various forums its commitment to most of the existing

macro-policies. While both the ANC and its alliance partners have

attempted to allay investor fears, they seem to have taken root in

some quarters.

We do not believe that the fiscal policy will be loosened to an extent

that will have a significant negative effect to the consumer. While

government expenditure may create jobs, and stimulate the economy,

it may also worsen our inflation outlook. It is our cautious opinion that

both COSATU and ANC are aware of this.

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2.2 Implications to Equities

Global financial markets apprehension with a Zuma-led governmenthas been aired in various media houses. We believe expectations

that Mr Zuma may lead the SA government may have already

been priced in, although we would not rule out further (negative)

impact on both the equity market and the rand.

Failure to convince global & local financial players that inflation will

remain a basis for monetary policy formation may lead to loss of

confidence. While we do not forecast a quasi Zimbabwe scenario

playing out in SA, foreign institutional managers may not interpret the

scenario positively, and a sell off of SA equities may ensure.

Post election, political uncertainty should reduce. It is difficult to infer

whether a political settlement in Zimbabwe will affect the local market,

and that is if it does take place. However, reduced political uncertain

and tension post elections should support valuations.

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3. Our 2009 Themes and the

Implications to Equity

3.1 Growth Will Decelerate Markedly.

We expect the GDP growth rate in South Africa to decelerate markedly on

account of (1) diminishing capital inflows (2) tighter liquidity and (3) waning

exports.

We expect capital inflows to diminish due to the current global

economic challenges, and should the global economy slide into a

recession, we expect FDI to be severely impaired. The creation ofproductive assets by foreign money will therefore decelerate, affecting

the growth rate of the country.

While we expect the Reserve Bank to reduce REPO rate in 2009 for

economic stimulation and also because inflation is expected to fall to

around 7%, we do not expect liquidity to be abundant as was the case

pre the National Credit Act era. The South African population is

probably optimally-borrowed already and liquidity in the market will not

be ease.

Waning exports will significantly affect the resource sector. Exports inmetals both base and special - will reduce on account of falling

demand from the major consumers such as USA, Europe, India and

China.

Source: Bloomberg

The Leading Indicators Index is already pointing to a decrease of

GDP, having decreased to below zero already.

SA Economic Indicators

2000 2001 2002 2003 2004 2005 2006 2007 2008F 2009F

Real GDP (yoy %) 4.15 2.75 3.68 3.1 4.85 5 5.35 5.1 3.4 2.15

CPI (yoy %) 5.33 5.73 9.15 5.97 1.39 3.4 4.64 7.08 11.65 7.1

Central Bank Rate (%) 12 9.5 13.5 8 7.5 7 9 11 11.5 9.5

3-Month Rate (%) 10.53 9.78 13.49 7.73 7.47 7.05 9.18 11.25 11.43 11.37

2-Year Note (%) 10.72 10.5 8.15 6.98 7.65 8.8 9.95 7.33 8.29

10-Year Note (%) 8.08 7.43 7.71 8.4 7.31 7.73

USDZAR 7.58 11.96 8.57 6.68 5.67 6.33 7.01 6.86 9.53 10.17

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Risks of a steeper deceleration in GDP growth rate to below the

Bloomberg consensus are understandable. However, we expect

infrastructural spending to underpin GDP growth rate this year. About

R500bn worth of projects in transport and power infrastructure,

and low cost housing are expected, limiting the extent of decline

in GDP growth rate. Our opinion is that it is a political imperative

for the government to roll-out the projects as a means of

absorbing excess labour in the economy.

South Africas interest rates are relatively high, (refer to section 3.2)

and internal demand can be stimulated by rate cuts. South Africa

simply posses leeway to stimulate the economy using interest rates.

Leading Indicators Index

-10

-5

0

5

10

15

20

Nov-02

Mar-03

Jul-03

Nov-03

Mar-04

Jul-04

Nov-04

Mar-05

Jul-05

Nov-05

Mar-06

Jul-06

Nov-06

Mar-07

Jul-07

Nov-07

Mar-08

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3.2 Interest Rates to Fall in Synch with Growth.

We expect 2009 to be punctuated by interest rates cuts. The major reasons

would be to stimulate the economy. Expectations of lower inflation would

also support interest rate cuts as demand would fall on account of lower

export demand and lower local spending capacity. The interest rate cuts will

have major implications to the equity markets, namely that it:

will lower the South African equities discount rate. The extent will

however be limited by the rising equity risk premium as we expect it to

go up from the general 5%-6% due to the global risk aversion. The

discount rate for South African equities should be much lower in late

2H09 on account of a lower risk free rate, and expectation of animproving global economy supporting valuations, and may catalyse

equity purchases.

should push up property technical values - thus reducing credit risk

faced by banks. Rather steady property prices were putting

considerable credit risk on bank balance sheets and an improvement

in property prices should reduce this risk. Nominal loan repayments

will also reduce in line with falling interest rates, which should ease the

default rates in banks.

stimulate growth in the real sector as working capital becomes

cheaper. Companies exporting to Africa may have a competitive

advantage despite the lower buying power capacity of the Sub Sahara

African (SSA ex SA) populace. The main advantage is that the

consumers in SSA ex SA are not overly debted, and transactions are

mainly on a cash basis. Average bank penetration rate in SSA ex SA

is only about 30%.

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The widening gap between the 3 month TB and the 10 year SAGB

yields indicates an inverted yield curve. Theoretically an inverted

yield curve is an indication of investors expectations of falling interest

rates in the future.

There is a concern that low interest rates will become inflationary. While this

view has some merit, we do note that:

interest rates remain relatively too high to forecast growth rates when

compared to the BRIC countries. This provides the monetary policy

committee with ample margin of safety to reduce rates without

triggering undesirable inflationary effects. We estimate South

Africas potential output at 5.6%, compared to Bloombergs

consensus figure of 2.2%, resulting in a positive output gap.

Generally, lower rates tend to be inflationary if the output gap is

negative.

higher deposit rates may also diminish consumers propensity to

consume, thus in turn hindering the rebalancing of the economy

towards consumption in the wake of a global recession.

3 Month TB vs. 10 Year SAGB Yields

4

6

8

10

12

14

16

18

20

22

24

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

3 Month TB

SABG 10YR

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Comparing South Africas interest rate, and the Bloomberg forecasts, we

take note of the following:

South Africa enjoyed low positive real interest rates in 2008, which

could have influenced the policy makers to continue to hike interest

rates. Brazil for instance has had a real interest rate of 7.6% in 2008,

relatively to South Africas 0.1%. However, compared to Russia, India

and China, our real interest rate seems mildly excessive given the

groups negative real interest rates (-1.0%, -3.7% and -1.9%

respectively).

South Africas real interest rate is expected to increase to 2.7% during

2009. Russia, India and China are still expected to enjoy negative real

interest rates, while Brazils real interest rate is expect to decline

slightly to 7.5%.

Using a simplistic approach where a neutral case is achieved

when interest rates equal GDP growth rate, we note that SA is

probably conducting the tightest monetary policy when

compared to the BRIC group of countries. In 2008, the interest

rate/GDP growth rate ratio of 3.5x is the highest. The 2009 forecast of

4.5x remains the highest again when compared to the BRIC.

The benefit of South Africas position is that it has room toreduce interest rates before reaching the neutral case.

On Interest rate/GDP growth rate, South Africa ranks badly against the BRIC

Interest Rate Growth Rate Inf lation Rate Real Interest Rate Interest Rate/GDP Growth

2008 2009F 2008 2009F 2008 2009F 2008 2009F 2008 2009F

Brazil 13.8% 12.8% 5.2% 2.9% 6.2% 5.3% 7.6% 7.5% 2.6 4.4

Russia 13.0% 9.5% 7.2% 5.0% 14.0% 12.0% -1.0% -2.5% 1.8 1.9

China 2.8% 2.5% 9.9% 8.3% 6.4% 3.6% -3.7% -1.1% 0.3 0.3

India 6.0% 5.3% 7.9% 6.9% 7.9% 6.7% -1.9% -1.5% 0.8 0.8

South Africa 11.8% 9.8% 3.4% 2.2% 11.7% 7.1% 0.1% 2.7% 3.5 4.5

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3.3 Compelling Relative Valuations May Persist in 2009

3.3.1 Current Market Valuation: Is it a screaming BUY?

Current valuations do offer an unsurpassed opportunity for investors, but we

do caution investors against indiscriminate buying. We do not recommend:

High beta companies (mainly Small Cap) which we believe will

continue to underperform the JSE ALSI as volatility

increases/continues.

Non-optimally leveraged companies because we believe a

protracted global recession will put pressure on companies top line

growth. This will negatively affect the companies interest coverage

ratio, making access to working capital more expensive.

Companies with weak cashflows. We expect liquidity to be

expensive in 2009, and companies with weak cashflows may find it

difficult to finance working capital. Strong cashflows will also be

important for companies that may seek to make acquisitions.

Our favoured shares

On a general view, we favour shares whose capitalisation is large (Top 60).

Again it is not random picking of the large caps, but we actually seek to pick

up large market caps that also offer growth. We favour shares that offer:

exposure to credit expansion, and sensitive to interest rate

reduction in a positive impact to their top-line;

exposure to public infrastructural build-out, as we expect some of

the R500bn government expenditure bill to be rolled out;

defensive characteristics to the current weak local and international

demand conditions. In this category, we remain fans of food retailers,

tobacco, brewery and pharmaceuticals.

cyclicality but only in late 2H of 2009. We expect cyclical stocks to

benefit from renewed global confidence and risk tolerance. We only

recommend exposure to Small Caps in the 2H09 also as they

would stand to benefit from our expectation of a recovery in the global

economy.

exposure to large market cap companies with growth

opportunities. We do not believe that exposure to large market

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capitalised companies should be random. Rather investors should

look for large cap companies with growth opportunities. Our fan in

category is the mobile telecom sector.


Premium/Discount to 10-Year Av. P/E ratio

Year Av. P/E

Premium/

Discount

1995 16.6 0.16

1996 17.3 0.20

1997 15.9 0.10

1998 14.7 0.02

1999 15.0 0.04

2000 14.6 0.01

2001 12.1 -0.16

2002 12.1 -0.16

2003 10.6 -0.27

2004 14.3 -0.01

2005 14.6 0.01

2006 16.4 0.14

2007 15.6 0.08

2008 13.1 -0.09

Current 7.3 -0.49

While the Av. P/E ratio

in 2008 shows only a

discount of 9% (lowerthan 16% in 2001 and

2002, and 27% in 2003),

the current P/E ratio is

at a discount of 49% to

the 10-year average P/E

ratio.

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Source: Bloomberg, Legae Calculations, as at 14.01.09

Premium/(Discount) to Average P/E Ratio of the Top 40

Company Sector P/EPremium/(Discount)to Average P/E

Harmony Gold Mining Mining 54.4 492%

AngloGold Ashanti Mining 20.4 122%

Naspers Ltd Media 16.3 77%

Shoprite Holdings Retail 15.8 71%

MTN Group Mobile Telecommunication 15.7 71%

Exxaro Resources Coal Mining 12.3 34%

SABMiller plc Brewery 11.4 24%

African Bank Investments Banking 10.3 12%

Kumba Iron Ore Mining 10.3 12%

Bidvest Group Conglomerate 9.3 1%

Average 9.2 0%

PPC Ltd Cement 9.2 0%

Tiger Brands Retail 8.9 -4%

Anglo Platinum plc Mining 8.3 -10%

Murray & Roberts Construction 8.1 -12%

FirstRand Ltd Banking 7.8 -16%RMB Holdings Banking 7.6 -17%

Sasol Ltd Chemicals 7.5 -18%

Sanlam Ltd Life Insurance 7.2 -21%

Reinet Investments SA Investments 7.2 -22%

Standard Bank Group Banking 6.8 -26%

Telkom SA Ltd Fixed Telecommunication 6.7 -27%

ABSA Group Banking 6.7 -27%

Nedbank Group Banking 6.3 -31%

BHP Billiton Mining 6.1 -34%

Impala Platinum Holdings Mining 6.1 -34%

Sapp Ltd Paper 6.0 -34%

Mondi Ltd Paper 5.5 -40%

Liberty Holdings Insurance 5.4 -41%

African Rainbow Minerals Ltd Mining 5.3 -42%

Arcelor Mittal SA Steel 4.9 -46%

Investec Led Investments 4.9 -47%

Aveng Ltd Construction 4.8 -48%Investec Plc Banking 4.6 -50%

Steinhoff International Furniture Retail 4.5 -51%

Remgro Ltd Investments 4.4 -52%

Lonmin plc Mining 4.3 -53%

Anglo American plc Mining 3.7 -60%

Old Mutual Life Insurance 2.9 -69%

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On relative valuation, South Africa is probably not a screaming buy,

like would seemingly be the case with Romania and Russia (P/E ratio

2.5X and 3.5X respectively). South Africas P/E ratio of 7.3X is

however still lower than the average P/E ratio of our select emerging

markets of 7.7X.

China still commands the highest P/E ratio in our selected universe

(14.2X) while other members of the BRIC family close the 2008 year

at P/E ratio that are lower than 10X Brazil = 8.8X, India = 8.5x and

Russia = 3.5x.

Using the GDP growth rate to calculate the PEG ratio for the JSE

since 1995, we observe that 2008s PEG ratio is below the average

PEG since 2000, while the forward PEG in 2009 will just be close to

the average.

Select Emerging Markets Closing P/E Ratios 2008

14.2

13.1

8.8

8.5

8.3

8.3

7.7

7.5

7.3

7.2

6.9

4.6

3.5

2.5

0 2 4 6 8 10 12 14 16

China

Israel

Brazil

India

Turkey

Average

Average

Egypt

South Af rica

Mauritius

Poland

Hungary

Russia

Romania

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Historical ALSI PEG Ratio (1995-2009)

0.000

5.000

10.000

15.000

20.000

25.000

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

P/Es (LHS) and PEGs (RHS)

2.97

0.70

1.21

1.78

3.53

1.00

3.00

5.00

7.00

9.00

11.00

13.00

15.00

17.00

Brazil Russia India China South Africa

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

P/E ratio

PEG

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We use Bloombergs 2009 GDP growth forecast to calculate the

PE/Growth (PEG) ratios. We then compare South Africa to the BRIC

member countries.

While South Africa has a relatively low P/E ratio when compared to the

BRIC, on a PEG basis, South Africa is the most expensive (PEG

=3.5x). This could indicate that on growth basis, South Africas

valuation may further de-rate since the current valuation is

weakly supported by growth (relative to the BRIC). Russia has the

least PEG ratio (0.7x).

Comparing the current P/E ratio to the JSEs historical, we note that

the years 1997,1998 and 2002 when the JSE recorded negative

returns, the monthly P/E ratio bottomed at 12.6X, 11.3X and 11X

respectively. In 2003 the P/E shrunk to 8.8X, but we believe this was

more a case of strong earnings growth than a case of falling share

prices.

The average P/E ratio since 1995 is 14.1X which is a premium of

93.1% to the current market valuation.


JSE ALSI P/E Ratio (1995-2008)

14.4

5.0

7.0

9.0

11.0

13.0

15.0

17.0

19.0

21.0

1-Jun-9

5

1-Jun-9

6

1-Jun-9

7

1-Jun-9

8

1-Jun-9

9

1-Jun-0

0

1-Jun-0

1

1-Jun-0

2

1-Jun-0

3

1-Jun-0

4

1-Jun-0

5

1-Jun-0

6

1-Jun-0

7

1-Jun-0

8

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We also bring attention to the fact that in general the market is

considered over-valued when the markets earnings yield is less

than the long-term Treasury bond yield. We note that the current

R157 yield is well below earnings yield of the market, and the gap

widened towards the end of the year 2008.

On a longer-term basis, the market was probably overvalued from

2002 to around 2005 (using the rationale of this model). It became

fairly valued up-to around mid-2007 before it became over-valued

again. A sharp convergence of the earnings yield and R157s yield

around September 2008 signals the end of over-valuation. Thereafter,

the markets earning yield become higher than the R157s yield,

pointing to possible undervaluation. However, the undervaluation is

not as clear-cut yet.


Earning Yield vs. R157 Yield (2008)

5.00

7.00

9.00

11.00

13.00

15.00

17.00

1/2/08

2/2/08

3/2/08

4/2/08

5/2/08

6/2/08

7/2/08

8/2/08

9/2/08

10/2/08

11/2/08

12/2/08

E. Yield

R157 Yield

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On a dividend yield basis, the market is trading at the highest dividend

yield since 2002. We are however unsure of the forward dividend yield

as we expect companies to cut their dividends, especially

financial/banking companies, retail and those whose leverage would

require extra cushion.


Earning Yield vs. R157 Yield 2002-2008

2

3

4

5

6

7

8

9

10

11

12

Dec-02

Mar-03

Jun-03

Sep-03

Dec-03

Mar-04

Jun-04

Sep-04

Dec-04

Mar-05

Jun-05

Sep-05

Dec-05

Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Earning Yield

R157 Yield

Dividend Yield (%) 2002-2008

4.02

3.21

2.69

2.93 3.00

2.70 2.78

4.67

3.25

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

2002

2003

2004

2005

2006

2007

2008Jan

2008Dec

Average

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While most metrics indicates undervaluation relative to historical

valuations (relatively low P/E ratio, and relatively high dividend yield),

we believe 2009 will be a year that will render relative valuation less

meaningful. Instead we prefer DCF-based valuations, or valuation

metrics (P/E, PBV ratios etc) based on fundamentals (growth and cost

of equity).

Our implied fundamental P/E ratio of the JSE is 9.5X (refer to section

5.1). Our fair value of the JSE Index is 24233.91, just about 9% higher

than the current value.

Because we expect fundamentals to be weak, and investors to use

valuation methods that incorporate risks (cost of equity) and

growth expectations, we expect valuations to remain weak and

appealing on a relative basis (relative to previous valuations).


We note that emerging markets sovereign spread widened to break

1000bp in 2001 and 2002. The widening of spread is steeper when

compared to instances when they narrow, which indicates a gradual

process.

Emerging Markets Sovereign Spread (bp)

0

200

400

600

800

1000

1200

22-Apr-01

22-Aug-01

22-Dec-01

22-Apr-02

22-Aug-02

22-Dec-02

22-Apr-03

22-Aug-03

22-Dec-03

22-Apr-04

22-Aug-04

22-Dec-04

22-Apr-05

22-Aug-05

22-Dec-05

22-Apr-06

22-Aug-06

22-Dec-06

22-Apr-07

22-Aug-07

22-Dec-07

22-Apr-08

22-Aug-08

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Current sovereign spread widened steeply again although it has not

yet broken the 1000bp. Given that we believe that the recession this

time around will be more protracted than the 2002, we anticipated the

spread to breach the 1000bp next year as investors fully digest and

realise the receding global economy.

Widening EM spreads suggest an increase in risk premiums assigned

to EM countries. This negatively affects our DCF-based and other

fundamental based equity fair values, again supporting our

expectations of relatively weak valuations in 2009, especially

when compared to historical values.

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3.3.2 How Does SA Compare to Other Resource-heavy

Markets?

We investigate how South Africa, whose market is resource heavy will fare

against other markets that are heavily, weighed to resources shares.


South Africas performance held very well with Australia and Canada

from 2002 to 2005, a point when both Canada and Australia started to

underperform South Africa. The performance gap is however

narrowing.

South Africa has the least P/E ratio of our resource based markets that

we selected.

Using the 2008 returns, the best performer is Australia in USD terms

while Russia takes the worst position. SAs 2008 is close to the mean

of the select resource-based markets, (-45.8% vs. -49.9%) which

again should one believe in reversion to the mean, then SAs upside

risk is limited.

South Africa Over-perform developed resource markets.

0.5

1.5

2.5

3.5

4.5

5.5

6.5

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

May-05

Sep-05

Jan-06

May-06

Sep-06

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

RSA: P/E = 7.7

Australia: P/E = 10.2

Canada: P/E =10.7

Brazil: P/E = 8.6

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Using the USD returns for the past 5 years, SA underperforms Russia

and Brazil (although the two markets underperform SA when 10-year

returns are used). However, both 5-year returns and 2008s returns do

not seem to wander from the mean of the resource-based markets.

USD returns for "Resource-heavy" Markets

-100.0%

-50.0%

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

Russia Brazil South Africa Canada Australia

Y2008

5 Yr Return

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3.4 Volatility May Persist on Earnings Surprise

Fundamentally, the risk of investing in SA equities has increased as

measured by volatility. Volatility has increased from below 15% in 2005 to

over 30%.


The volatility of the JSE ALSI increased markedly in 2008. It touched

30%, which historically was not achieved even in 1988 when EM

markets faced immense volatility.

Our expectation of persistence in volatility next year is based on

our expectation of material earnings surprises both upside and

downside. We however also note that historically, volatility would

rise during periods of bubbles and recessions, and stay relatively

high for a period of one year or two. In 1998, volatility remained

high up-to around 2000, and in 2002 shot up and remained relativelyhigh up-to the end of 2003.

90-day Historical Volatility of the JSE ALSI

5

10

15

20

25

30

35

1/30/98

7/30/98

1/30/99

7/30/99

1/30/00

7/30/00

1/30/01

7/30/01

1/30/02

7/30/02

1/30/03

7/30/03

1/30/04

7/30/04

1/30/05

7/30/05

1/30/06

7/30/06

1/30/07

7/30/07

1/30/08

7/30/08

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4. Valuation

4.1 Market Valuation

We attempt to value the JSE All Share Index (JSE ALSI). We use the

Dividend Discount Model (DDM). We also introduce our Top picks of the

year 2009.

Our inputs for the DDM are as follows:

the Dividend estimate (D1) of the JSE ALSI (I-Net)

the Cost of equity (ke) which we calculate as a combination of the risk

free rate and the risk premium.

Growth Rate (g) which we equate to our estimated nominal GDP

growth rate.

Our equity risk premium is the average of the sum of the difference between

the return of the market (JSE ALSI = Rm) and the risk free rate (R157 = Rf).

(i.e. Equity Risk Premium = [(Rm Rf)/n- 1]. We estimate the risk

premium from 1996.

We recognise that this observed excess return may be different from the

expected excess return by investors, especially in light of the global

recession. This expectation of higher returns has already been observed in

the widening of the EM sovereign risk premium. For the sake of reducing

subjective estimates, we do not adjust our observed ERP to reflect these

expectations.


Calculation of our Equity Risk Premium

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 ERP

Mark et Return 7.1% -8.2% -8.6% 66.8% -2.6% 28.1% -11.3% 12.0% 21.9% 43.0% 37.7% 16.2%

SAGB 10 YR 16.2% 13.8% 16.0% 13.7% 12.7% 11.5% 10.6% 9.2% 8.2% 7.4% 7.8% 8.4%SAGB 30 YR 16.3% 13.8% 15.9% 13.6% 12.6% 11.4% 10.1% 8.9% 7.2% 6.8% 7.2% 8.0%

ERP 10YR -9.1% -22.0% -24.6% 53.2% -15.4% 16.5% -21.8% 2.8% 13.7% 35.5% 29.9% 7.9% 5.5%

ERP 30YR -9.2% -22.0% -24.5% 53.3% -15.2% 16.7% -21.4% 3.1% 14.6% 36.2% 30.4% 8.3% 5.9%

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Below we value the JSE ALSI.


Our fair valuation of the ALSI value is 24,233.91, providing no

fundamental value by a return of just 9.1%. This upside risk to the

current valuation would not provide real return.

There are risks to our valuation. The major risk is our dividend growth

rate which we estimated at 9.25%. We bring investors attention to the

fact that when we calculated the index dividends using the dividend

yield of the ALSI since 1995, the average growth rate of the dividends

came up at a higher value of 16.7%.

DDM Valuation

LT Bond Yield 7.49% R157 Yield

Equity Risk Premium 5.90% Legae Estimate

Equity Discount Rate 13.39%

JSE ALSI Dividend (2008) 918.34 Bloomberg

Dividend Growth Rate 9.25% Legae Estimate

Cost of Equity 13.39% Legae Estimate

JSE ALSI Value 24233.91

JSE ALSI EPS (2008) 2554 Bloomberg

Implied P/E Ratio 9.5 Legae Estimate

Current P/E Ratio 7.3

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4.2 Our 2009 Top Picks

Below we present our top picks of the year 2009.

For 1h09, we sought shares that have large, sustainable balance sheets, a

reasonably defensive business model and transparent growth

characteristics. We are not of the opinion that markets will immediately re-

gain confidence in spite of the expected global economic recovery in H209.

To that end, we advise investors to be selective buyers of SA equities ahead

of 2H09.

Source: Bloomberg, Legae Securities

Our 2009 Stock Picks

H1 2009 Picks

Name

Bloomberg

Ticker

Market Cap

Rmn

Price

cents P/E

5-Yrs Av.

P/E PBV

Div.

Yield BetaMTN MTN SJ 187,925.94 10060 16.4 15.9 3.0 1.4% 1.0

Shoprite SHP SJ 29,891.37 5500 17.7 15.8 6.3 2.8% 0.4

BAT BTI SJ 527,092.92 26029 15.8 16.4 5.5 4.0% n/a

Tiger Brands TBS SJ 24,027.03 13885 9.1 11.6 n/a 5.6% 0.6

Bidvest BVT SJ 33,653.60 10117 9.5 11.4 3.6 4.85% n/a

Aspen APN SJ 15,271.89 3825 16.2 21.3 4.4 n/a 0.5

Spar SPP SJ 9,630.00 5600 13.8 n/a 6.4 5.0% 0.6

H02 2009 Picks

Murray & Roberts MUR SJ 15,600.00 4531 8.1 13.6 3.1 4.2% 0.8

Old Mutual OLM SJ 45,960.12 871 3.1 8.5 0.4 5.5% 0.9

Richemont CFR SJ 172,780.00 1625 5.4 n/a 1.1 5.4% 0.7

Truworths TRU SJ 16,110.00 3507 11.9 10.9 5.1 4.0% 0.6

Absa ASA SJ 74,930.00 10705 6.8 8.0 1.8 5.3% 0.6

Steinhoff SHF SJ 16,802.76 1227 4.6 9.8 0.7 5.1% 0.8

PPC PPC SJ 16,680.00 2717 8.9 14.8 7.6 7.2% 0.5

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Our neutral case foresees a stable currency in 2009, weaker domestic

and global demand and lower interest rates. The combination of weaker

commodity prices and a stable currency is negative for mining stocks. Lower

interest rates should support domestic interest rate sensitive stocks, which

are also likely to anticipate a recovery in activity in 2H09. Our preferred

exposure to SA equities is for domestically-biased companies with a

mix of gearing to lower interest rates, relatively stable earnings growth

and reasonable valuations. In 1H09, we continue to favour Tiger Brands

which should enjoy good earnings growth in 2009. Despite some macro risk

in Nigeria we continue to favour MTN which offers exposure to growth in

mobile phone usage in Africa (ex-South Africa mobile penetration in MTNs

coverage is approximately 30%). Our other preferred picks are:

BAT: since 2000, compounded shareholder return has been 28.3%,

adjusted EPS growth is 10% p.a. BAT will likely achieve modest

outperformance over mid-term. BAT is on an 11.7x forward PE

(CY09) whereas its peers are on a slightly lower 11.5 times forward

PE. Gearing for BAT is low relative to Imperial Tobacco and while

corporate bond spreads remain wide, the higher rating that BAT

enjoys could be maintained.

TBS: we like its defensive properties which are underpinned by stronggrowth and a relatively cheap valuation. We expect growth within the

group to accelerate in FY09 as raw material prices decline while sales

prices remain relatively stable. This growth is further supported by

some of FY08s underperforming divisions normalising in FY09, most

notably the beverages and bread divisions.

APN: has grown to become the leading generics company in South

Africa. It has expanded into Australia and has gained market

leadership in AIDS drugs in the sub-Saharan region. Through

acquisitions, APN gained access to high growth, high margin LatAm &

generic oncology markets, but also broadened its reach via co-

operations. The full potential is not yet visible with Aspen shares

trading at a discount to its peers.

SPP: We expect food inflation to remain above 14% until mid-1Q09

and then expect it to roll over, averaging double digits for the full year.

This combined with significantly lower petrol prices should bode well

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for FY09. SPP has continued to gain market share on the back of

space growth and solid performance.

BVT: has a strong cash generation track record, is relatively under

geared, has world-class management that runs some valuable

businesses, benefits from a weaker ZAR and capitalises on inflation

due to its trading nature. The business mix is diverse. Corporate

action remains a key driver of the share price given its successful

track record.

For cyclicality (in 2H09), we prefer ABSA (gearing to lower interest rates,

superior earnings versus the sector) and Murray and Roberts (strong

gearing to public sector infrastructure investment, best earnings in the

sector, following a sharp fall in the share price fears over a slowdown in

construction now fully priced in). Other members of our 2H09 preferred

shares are:

SHF: Although all regions where Steinhoff operates are experiencing a

broader slowdown, the group continues to re-iterate that it is well

positioned to weather the economic downturn. Operations in the UK

are trading flat, while those across Germany and Eastern Europe are

trading up in local currency terms. Australia appears to be improving

on the back of recent interest rate cuts. The South African logisticsoperations continue to perform well.

TRU: Despite a tough trading environment, TRUs sales are currently

14% higher than last year. Trading space year on year has increased

10%, while product inflation is hovering at 6%. Same store sales are

currently up 8%.

RCH: Richemont is the world's second largest luxury goods group. It

owns one of the world's best-known luxury brands in the guise of

Cartier. It also owns some of the most recognisable luxury watch

names such as IWC, Vacheron Constantin, Panerai and Jaeger-LeCoultre.

PPC: Cement demand growth continues in SA, due to increased

infrastructure investment. PPC trades on a forward PE of 9.6x, an 8.6

percent discount to the industrials index, and has traded as high as a

50 percent premium to this index. It has dominant market share and

strong cash flow generation.

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OML: Key positives are: huge scope for operating performance to

improve, scope for strategic refocusing, new management team might

solve structural problems. Key concerns are: South African country

risk increasing, confirmed by Rand weakness. Outlook tough given

commodities crash. Solvency surplus now below management target,

implies high risk of capital raising and dividend cut. Potential sale of

Nedbank could struggle to find buyers.

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Legae Securities (Pty) Ltd

Member of the JSE Limited

6-10 Riviera Road, Houghton, Johannesburg, South Africa

P.O Box 87277, Houghton 2041, Johannesburg, South Africa

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as expressed in this document

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