Hunker down in rand hedges

Buckle up for a tough sit­u­a­tion wors­en­ing even fur­ther in 2017. The only hope is to go very de­fen­sive and wait for the bulls to re­turn.

Finweek English Edition - - THE PESSIMIST’S GUIDE: STOCK PICKS - Ed­i­to­rial@fin­week.co.za *The writer owns shares in Metro­file, Sho­prite, CSP500, Brait and Stein­hoff

if you thought 2016 was a tough year, hang on to your hats be­cause 2017 is go­ing to show us that last year was just the warm up. In the lead-up to the ANC elec­tive con­fer­ence in De­cem­ber we’re likely go­ing to ex­pe­ri­ence a deaf­en­ing roar from the rul­ing party as mem­bers jockey for po­si­tion. On the back of this (and in part be­cause of the noise) growth will con­tinue to limp along – hardly able to get above 1% and the rat­ing agen­cies will be cir­cling, ea­ger to make us junk. Likely they will strike in June, down­grad­ing us and wors­en­ing a tough sit­u­a­tion.

For­eign in­vestors who have been sell­ing lo­cal eq­ui­ties and bonds will sell with in­creased speed, push­ing our mar­ket lower and the rand weaker against ma­jor cur­ren­cies and in­creas­ing our cost of gov­ern­ment debt as buy­ers shy away from new bond of­fer­ings.

Com­mod­ity prices will most likely kick off the new year by mov­ing sharply lower as traders re­alise there is no im­proved de­mand and that over­sup­ply re­mains the re­al­ity. The weaker com­mod­ity prices will see a rush out of mining stocks and even the weaker rand won’t be able to save the day as we see the lo­cal mining stocks col­laps­ing af­ter their amaz­ing 2016 run.

A weaker rand also means inflation will rear its head and while the Re­serve Bank is wor­ried about growth, it might ul­ti­mately de­cide that ram­pant inflation is the big­ger con­cern – in which case it will start to raise rates when the hope had been for rate cuts dur­ing 2017. This will lead to the con­sumer start­ing to crack on the back of higher inflation, in­ter­est rates and trans­port costs.

Bank­ing sec­tor

So, af­ter a shock­ing 2016 for re­tail stocks, 2017 could get worse with sales go­ing back­wards, send­ing the shares to mul­ti­year lows with no sign of re­cov­ery. Bank­ing stocks could be hit es­pe­cially hard as their non-per­form­ing loans (NPLs) sky­rocket.

In this worst-case sce­nario, how does one build a port­fo­lio and make money from your in­vest­ments? We need to go very de­fen­sive with many rand hedges, clear­ing the decks of re­tail and bank­ing stocks with the lat­ter suf­fer­ing from the double hit of the down­grade to junk and a wors­en­ing con­sumer sit­u­a­tion.

The NEWUSD ex­change-traded note (ETN) from Absa would be a firm favourite. As the rand weak­ens, this ETN will move higher in lock­step with the cur­rency. But as it of­fers no op­er­a­tional lever­age, we should also look to du­al­listed stocks and those mak­ing sig­nif­i­cant prof­its in dol­lars and pounds.

Brexit

Brexit will con­tinue to haunt the UK and beaten-down Brait* and Stein­hoff* will both of­fer a hedge against the weaker rand. While their op­er­at­ing mar­kets are un­der pres­sure, ex­cel­lent man­age­ment teams, and global ex­pan­sion in the case of Stein­hoff, will see im­proved prof­its com­ing through when these are con­verted to rand.

An easy win will be the US mar­kets as they con­tinue higher into new all-time highs. Cou­pled with a weak rand, the new CoreShares S&P 500 ex­change-traded fund (ETF), CSP500* will soar from the double boost of higher US mar­kets and weaker rand, both adding to its value.

An easy win will be the US mar­kets as they con­tinue higher into new all-time highs.

Food sec­tor

Food re­tail­ers will see some light at the end of the tun­nel as the rains re­duce the cost of pro­duc­tion and hence take some pain out of food inflation, but with con­sumers un­der pres­sure this space will con­tinue to be tough. Sho­prite* is one food re­tailer that should be able to benefit as con­sumers shop down. Its rest of Africa oper­a­tions should do well and see in­creased prof­its thanks in part to a

weak rand.

Small-cap stocks

With the over­all mar­ket weak and mov­ing lower, small- and mid-cap stocks will be es­pe­cially hard hit as liq­uid­ity dries up. In­vestors just stay away from the smaller stocks when trou­ble hits, so ex­pect them to be es­pe­cially vul­ner­a­ble. The right strategy is to exit them sooner rather than later, es­pe­cially in the case of those with mostly lo­cal ex­po­sure. Metro­file* may be an ex­cep­tion as it has a very de­fen­sive business in stor­ing doc­u­ments that are a le­gal re­quire­ment for com­pa­nies and its strong cash gen­er­a­tion will en­sure an at­trac­tive div­i­dend yield. The most im­por­tant point to re­mem­ber is that bad times never last for­ever, so while it will be tough, we need to pro­tect our port­fo­lios to benefit when the bulls re­turn.

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