Eq­ui­ties re­silient de­spite eco­nomic chal­lenges in SA

Finweek English Edition - - INSIDE - BY ALEC SCHOE­MAN Head of Eq­ui­ties at Citi South Africa

As South Africa’s econ­omy con­tin­ues to come un­der strain from power sup­ply con­stra ints and the in­creas­ing threat of ag­gres­sive industrial ac­tion from or­gan­ised labour, the eq­ui­ties mar­ket is be­ing forced to shift the weight­ing of its var­i­ous sec­tors. While t he re­sources sec­tor comes un­der pres­sure, other ser­vice sec­tors are start­ing to take up the slack as the big­gest value driv­ers.

South Africa has his­tor­i­cally been seen as a re­source-based econ­omy, but this has shifted dramatically in re­cent years. In 2008, 55% of the mar­ket cap­i­tal­i­sa­tion of the JSE was in the re­sources sec­tor; it is now cur­rently sit­ting at around 35%, a ma­jor tran­si­tion.

De­spite the decline in re­sources, the South African eq­ui­ties mar­ket re­mains re­silient and the over­all in­dex made new all-time highs again in late April.

There are a sig­nif­i­cant num­ber of stocks that are al­ready at all-time highs, mainly in the fi­nan­cials and in­dus­tri­als sec­tors; how­ever, very few re­source names are mak­ing new highs.

One of t he big t hemes of 2014 was the ro­ta­tion of cap­i­tal from other emerg­ing mar­kets into South African eq­ui­ties; a trend that has con­tin­ued strongly in 2015. A big geopo­lit­i­cal theme driv­ing the strength of the South African eq­ui­ties mar­ket at the mo­ment is the per­sis­tent ten­sion be­tween Rus­sia and the Ukraine, which started in March last year and con­trib­uted to the eq­uity inf lows that we saw at mid-point last year.

It con­tin­ues to be a cru­cial geopo­lit­i­cal hotspot even with progress on cease­fire ne­go­ti­a­tions, but Rus­sia i s be­ing viewed as al­most un­in­vestable by some in­ter­na­tional funds.

As a re­sult, SA is now viewed as much more of a rel­a­tive safe haven. There are sev­eral neg­a­tives in the macro econ­omy and Eskom, with its power sup­ply is­sues, is prob­a­bly the most prom­i­nent prob­lem right now. But it seems that most neg­a­tives in SA are well known and well f lagged by in­vestors. If any­thing, they are prob­a­bly get­ting priced in more neg­a­tively and more ag­gres­sively than what the un­der­ly­ing sit­u­a­tion re­ally war­rants.

From that per­spec­tive, if SA can show some in­cre­men­tal im­prove­ment in pol­icy, we’ll begin to see some strong gains on the JSE, and that doesn’t re­quire a 180° overnight mir­a­cle that boosts our GDP – to 8%.

What we need to do is to start show­ing that the tide is slowly turn­ing. There are a few key events this year that will lead up to that, the f irst of those be­ing the re­cently held Na­tional Bud­get

and Pres­i­dent Ja­cob Zuma’s State of the Na­tion ad­dress.

The South Africa Re­serve Bank (Sarb) is likely to leave in­ter­est rates un­changed in the medium term and the up­dated broad-based black eco­nomic em­pow­er­ment (B-BBEE) codes are set to come into ef­fect in May.

Also, Deput y Pres­i­dent Cyril Ramaphosa has voiced his in­ten­tion to de­velop in­ter­ven­tions to pre­vent industrial ac­tion sim­i­lar to the drawnout strikes we saw last year.

The gold price has over­taken the plat­inum price, which is a bear­ish in­di­ca­tion for risk ap­petites. Gold has been driven by safe-haven de­mand while plat­inum has not seen an uptick in its industrial us­age.

The de­mand side for industrial us­age may be as­sisted by Euro­pean quan­ti­ta­tive eas­ing (QE), though car sales across the EU con­tinue to rise with­out boost­ing plat­inum.

In the sec­ond half of last year, re­source stocks came un­der tremen­dous pres­sure. Be­sides the oil price hav­ing halved from where it was at this stage last year, we saw iron ore prices drop 40% and cop­per sell off. There’s a very risk-averse sen­ti­ment to­wards min­ing play­ers gen­er­ally at the mo­ment, and wari­ness on their turn­around po­ten­tial.

The sec­tor that re­ally out­per­formed the mar­ket into the back end of last year was prop­erty. South African real es­tate in­vest­ment trusts strength­ened on the back of a global search for higher yield in a f lat rate en­vi­ron­ment. In the global con­text, SA is still rel­a­tively higher yield­ing when it comes to bond prox­ies, be­ing listed prop­erty and high div­i­dend pay­ing stocks.

The sec­tor at­tracted strong de­mand in a global en­vi­ron­ment which is show­ing lower and lower rates. In the last month, since the start of the year, there have been over 10 cen­tral banks that have cut rates in an at­tempt to boost eco­nomic growth.

The ex­cep­tion is the US, which likely will raise rates this year, con­trary to the eas­ing trend else­where. World economies are strug­gling to see inf la­tion pushes com­ing through into their mar­kets as there sim­ply isn’t enough de­mand for goods to push prices higher while sup­ply re­mains high – ob­vi­ously ev­i­dent in oil and iron ore, amongst many other ex­am­ples.

But again, this demon­strates the vul­ner­a­bil­ity of mar­kets when it comes to growth and how the US has dis­tanced it­self from ev­ery­one else. They’ve gone through their own quan­ti­ta­tive eas­ing (QE) cy­cle. The next course of ac­tion is for them to raise rates and re­sume more ‘nor­mal’ mon­e­tary pol­icy.

The US is show­ing good eco­nomic growth num­bers and out­strip­ping all five Brics na­tions. At this stage, we have to ask our­selves why risky emerg­ing mar­kets de­serve any kind of de­mand pre­mium if they can’t achieve greater growth than es­tab­lished ‘safer’ eco­nomic ti­tans like the US. Emerg­ing mar­kets need to prove their mer­its.

In the South African con­sumer sec­tor, it was ba­sic ne­ces­sity-type industrial con­sumer play­ers that out­per­formed last year, health­care and phar­ma­ceu­ti­cals in par­tic­u­lar.

Aspen had a great r un last year and hos­pi­tal stocks had ex­tremely strong per­for­mance, along with food pro­duc­ers. Tiger Brands, Pi­o­neer and AVI recorded very strong per­for­mance in the back end of last year, ben­e­fit­ting from a low in­fla­tion­ary en­vi­ron­ment and in­elas­tic con­sumer de­mand de­spite tough eco­nomic con­di­tions.

The worst per­form­ers, how­ever, in­cluded the listed con­struc­tion sec­tor, which is down in the re­gion of 30% year on year and – 27% year to date.

Re­sources re­main lag­gards – with iron ore stag­nant with­out any real sup­port as sup­ply vastly out­strips de­mand. Although gold ran strongly to start the year from $1 200 to $1 300 an ounce in the first three weeks, which pushed the sec­tor very strongly, it’s back to $1 200.

While the re­sources sec­tor con­tin­ues to strain un­der poor de­mand and a chal­leng­ing en­vi­ron­ment, the cycli­cal na­ture of the mar­kets means that the sec­tor will re­cover even­tu­ally. In the mean­time fi­nan­cial and industrial shares con­tinue to drive growth in our mar­ket.


Cyril Ramaphosa

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