Af­ter a mag­nif­i­cent seven-year run for lo­cal eq­ui­ties, storm clouds are gath­er­ing. The South African econ­omy is vir­tu­ally stalled, and the US – like South Africa – is ex­pected to en­ter a cy­cle of ris­ing in­ter­est rates, which raises bor­row­ing costs for com

Finweek English Edition - - FRONT PAGE - BY CIARAN RYAN

The JSE All Share In­dex (Alsi) i s up 248% i n t he l ast 10 years. That’s a growth of 13.25% a year, more t han dou­ble the av­er­age inf la­tion rate for the pe­riod.


Be­cause sev­eral of the en­gines pow­er­ing this growth are stalling. Two ma­jor fac­tors fore­shad­ow­ing darker days for eq­uity in­vestors are the Chi­nese eco­nomic slow­down, which has al­ready knocked nearly 40% off the Global Base Met­als In­dex over the last year, and the end of the era of low in­ter­est rates.

Loom­ing over the lo­cal mar­ket is the out­look for the rand, which is down 9% against the US dol­lar this year, and more than 40% since 2011. Sev­eral mar­ket an­a­lysts be­lieve the rand is heav­ily over­sold and could strengthen over the next year, which would take some of the froth off rand hedge stocks.

The heav y weights of t he JSE have i noc­u­lated t hem­selves against slug­gish do­mes­tic growth by in­vest­ing abroad. Fif­teen of the big­gest com­pa­nies on the JSE now earn more than half their rev­enue off­shore. These in­clude MTN, Bid­vest, Stein­hoff, Naspers, SABMiller, Bri­tish Amer­i­can To­bacco, Glen­core and BHP Bil­li­ton. The dom­i­nance of these hard cur­rency earn­ers in the in­dex helps ex­plain the out­size per­for­mance of the JSE at a time when the do­mes­tic econ­omy is at a vir­tual stand­still.

A weak rand may be good for the Alsi, but lit­tle else. It ben­e­fits ex­porters and com­pa­nies with for­eign busi­nesses, but also fu­els in­fla­tion and spreads poverty. Over the past 20 years, South Africans have be­come 6% poorer each year when mea­sured in US dol­lar terms, ac­cord­ing to David Shapiro, deputy chair­man at Sas­fin Se­cu­ri­ties.

Play­ing the rand hedge game has been a dom­i­nant theme among in­vestors in re­cent years. And rightly so. But what if the rand were to re­turn to R10 to the US dol­lar? While there is noth­ing on the hori­zon to sug­gest a re­ver­sal, War­ren In­gram, di­rec­tor at Galileo Cap­i­tal, be­lieves the rand at R12.70 to the dol­lar is hor­ri­bly over­sold.

“There is a strong cor­re­la­tion be­tween the rand and the com­mod­ity cy­cle, which has

been weak­en­ing in re­cent years. I don’t see much ad­van­tage in send­ing a lot of money out of SA at this stage,” says In­gram.

“If we look back at the early 2000s, we get a sense of what can hap­pen. At that time the rand fell to about R12 to the US dol­lar and then clawed its way back to around R6. If you send money out at R12.70 to the US dol­lar, and the rand strength­ens from here, you are look­ing at a cer­tain loss.”


Another de­vel­op­ment wor­ry­ing lo­cal in­vest­ment man­agers is the slow­down in the Chi­nese econ­omy, which has al­ready knocked about 40% to 50% off com­mod­ity prices for cop­per, i ron ore, coa l a nd gold. This, cou­pled with r ising labour and in­put costs as well as elec­tric­ity sup­ply dis­rup­tions, has dev­as­tated t he re­sources sec­tor which now ac­counts for just 23% of the JSE’s mar­ket cap­i­tal­i­sa­tion, com­pared to 43% i n 1994. The com­modi­ties su­per cy­cle, fu­elled by China’s mas­sive i nvest­ment i n man­u­fac­tur­ing, pushed t he Met­als in­dex up four-fold be­tween 2001 and 2007. It has been in steady de­cline since 2011. Eq­uity prices have been but­tressed by low in­ter­est rates for much of the last decade. In June the Re­serve Bank hiked its key repo rate by 0.25% to 6%, sig­nalling what may turn out to be the end of the era of sus­tained low in­ter­est rates. This had lit­tle ef­fect on the JSE, but any fur­ther in­creases in rates will al­most cer­tainly take some of the shine off eq­ui­ties as an as­set class.

In a re­cent re­port Shaun le Roux, port­fol i o man­ager at PSG As­set Man­age­ment, says that although the JSE Alsi seems to be un­der­go­ing a mild cor­rec­tion, hav­ing fa l len 7% from its peak in April this year, in US dol­lar terms the in­dex has lost about 18% over the past year.

“The more pop­u­lar parts of t he mar­ket, per­ceived to be of higher qual­ity or pro­duc­ing more con­sis­tent prof it growth, have been on a tear over the past year – with sev­eral of the pop­u­lar names post­ing year-on-year gains in ex­cess of 50%,” says Le Roux. “On the other side of the per­for­mance charts, re­source coun­ters have had a tor­rid time over the past year. At an in­dex level share prices have de­clined by 43%,” he says.



The one ray of light in all this gloom is the 50% drop in the price of crude oil over the past year, which has helped keep in­fla­tion un­der con­trol. But that ben­e­fit has all been wiped out by the de­cline in met­als and min­er­als prices on which we de­pend for ex­port earn­ings. And while rand weak­ness in the past has helped boost ex­port com­pet­i­tive­ness, that ad­van­tage has dis­ap­peared due to lack of elec­tric­ity sup­ply and labour un­rest.

At a re­cent JPMor­gan con­fer­ence, an­a­lysts were asked which emerg­ing mar­ket coun­try of­fered the big­gest in­vest­ment op­por­tu­nity over the next two years. Not a sin­gle an­a­lyst named SA, ac­cord­ing to a re­cent re­port by Coro­na­tion Fund Man­agers. They named Brazil as the top op­por­tu­nity, fol­lowed by In­dia, Rus­sia and Mexico.

ArcelorMit­tal ’s i nterim re­sults pub­lished i n July summed up t he do­mes­tic en­vi­ron­ment: “Lo­cally, the econ­omy is nearly at a stand­still due to elec­tric­ity con­straints, in­fra­struc­ture de­vel­op­ment de­lays and the low spend­ing in the min­ing sec­tor.”

“South African com­pa­nies have now opted to fo­cus on in­vest­ments that in­crease pro­duc­tiv­ity to com­pen­sate for salary in­creases rather than in­vest in growth projects,” it stated.

Shapiro says SA’s growth for the next three years is likely to range be­tween 2% and 2.6%, which is a good per­cent­age point be­low the forecast global mean of 3.3% to 3.6%. That means we are likely to un­der­per­form not only other de­vel­op­ing economies, but de­vel­oped economies such as the US and UK.

“Our growth is likely to be lower than our de­vel­op­ing coun­try peers and even de­vel­oped economies such as the US and UK. The down­ward shift in com­mod­ity prices poses a ma­jor threat to growth and so­cial or­der. Lower com­mod­ity prices will ben­e­fit con­sumer coun­tries, par­tic­u­larly Europe and the US. Fall­ing oil prices should pro­vide some re­lief,” he ex­plains.

Also dis­con­cert­ing is the di­ver­gence

be t ween t he J SE a nd busi ne ss c onf i dence ( se e g r aph on le f t). Con­fi­dence is at the low­est level it’s been in a decade, the re­sult of a laun­dry list of ills ac­cord­ing to Shapiro, in­clud­ing Eskom out­ages, over­reg­u­la­tion of the econ­omy, strained labour re­la­tions and threats to pri­vate prop­erty.

The dispa ri t y bet ween eq­uit y prices and a de­te­ri­o­rat­ing eco­nomic en­vi­ron­ment makes lit­tle sense un­til one starts to un­pack the com­po­nents of the Alsi. Says In­gram: “The JSE is hid­ing mas­sive dis­par­ity be­tween five to eight glam­our shares which are very ex­pen­sive, ver­sus the en­tire re­sources sec­tor, which is cheap. So look­ing at the in­dex on its own does not [pro­vide] the full pic­ture.”



For­eign an­a­lysts have turned neg­a­tive on SA and emerg­ing coun­tries in gen­eral. Stephen Mein­t­jes of Imara SP Reid told Fin­week this neg­a­tiv­ity cre­ates at­trac­tive op­por­tu­ni­ties on the JSE. “An in­creas­ing num­ber of for­eign in­vestors re­alise that not only do emerg­ing mar­ket economies dif­fer widely in many ar­eas – in­clud­ing cor­po­rate gov­er­nance in the pri­vate sec­tor – but the JSE, while by no means i nde­pen­dent of t he South African GDP, is rel­a­tively re­silient,” he says. “This is due to the need, over many decades, to di­ver­sify out­side the lo­cal econ­omy due to lim­ited growth prospects. Need­less to say, the school fees were high over the years but many are get­ting it right.”

The di­ver­sif ica­tion by SA Inc pro­vides JSE in­vestors a nat­u­ral hedge against rand weak­ness, but buy­ing the in­dex alone may not be diver­si­fi­ca­tion enough. In­vestors will have to hunt harder for value stocks ca­pa­ble of smooth­ing any tur­bu­lence ahead.

In a re­cent re­port to in­vestors, Coro­na­tion Fund Man­agers says global f inan­cial mar­kets con­tinue to be i mpac te d b y the now ex­tended pe­riod of ex­tra­or­di­nary ac­com­moda­tive mon­e­tary pol­icy a ppl ie d i n most of t he ma­jor economies around the world. “While Euro­pean, Ja­panese and Chi­nese author­i­ties have be­come even more ac­com­mo­dat­ing, mar­kets have started to dis­count a slow nor­mal­i­sa­tion in in­ter­est rates in the US. This has re­sulted in a pe­riod of sig­nif­i­cant US dol­lar strength, with most cur­ren­cies re­main­ing un­der pres­sure.”

We are now in the sev­enth year of a bull mar­ket sup­ported by low in­ter­est rates, which have come to be ac­cepted by in­vestors as the norm. The re­sult is ex­ag­ger­ated val­u­a­tions for most as­set classes, par­tic­u­larly high-qual­ity com­pa­nies that have his­tor­i­cally paid re­li­able div­i­dend yields. “This is due to these busi­nesses in­creas­ingly be­ing seen as prox­ies for bonds that are pro­duc­ing record-low yields. This, as a broad sim­pli­fi­ca­tion, has led to an en­vi­ron­ment where in­vestors have to ven­ture fur­ther down the qual­ity curve to f ind at­trac­tive val­u­a­tions,” ac­cord­ing to Coro­na­tion.

While the tim­ing of the f irst in­ter­est rate hike in the US may be un­cer­tain, a nor­mal­i­sa­tion of ab­nor­mal mon­e­tary pol­icy re­mains in­evitable.

The US eco­nomic re­cov­ery is on track, and the f irst real signs of inf la­tion pres­sure are emerg­ing as wages start to climb in a tight­en­ing labour mar­ket.

For re­tirees re­liant on sta­ble mont hl y i nc ome, t he se ar e chal­leng­ing times. Cor­po­rate bonds in well-funded in­sti­tu­tions can be at­trac­tive, as are some pref­er­ence shares, but these are of­ten highly illiq­uid. Fixed prop­erty sim­i­larly of­fers a sta­ble yield, but there is the risk of ten­ants de­fault­ing as we head into the eco­nomic down­turn.

Doug Tur­vey, pri­vate cl ient port­fo­lio man­ager at Cannon As­set Man­agers, says sta­ble i ncome­seek­ing in­vestors will need to be pa­tient, re­al­is­tic and tem­pered in their ex­pec­ta­tions.

“The ex­cite­ment and op­por­tu­nity prob­a­bly lie in the eq­uity-cen­tric yields, cor­po­rate bonds, l isted prop­erty and pref­er­ence shares for now,” he says.



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