Finweek English Edition
WHERE TO GO WHEN THE MARKETS ARE ALL OVER THE PLACE
The world is awash with cheap cash. An apparent disconnect between Wall Street (the financial markets) and the High Street (the real economy) is starting to make long-term investors anxious about what will happen once the risk-taking mood disappears. finw
“The fear of missing out has caused some to abandon any defence in their portfolios and risk scoring a few own goals in the process.”
there is a saying that when a New York taxi driver asks you what share they should buy, you should sell all your stocks immediately on getting out of the taxi: a bubble is developing. The adage is that when Wall Street meets the High Street, alarm bells should ring.
It is, unfortunately, not that easy to go out and “sell all your stocks”. Trying to time the market – even when it is overheating – is a fool’s game, and leaves the participants poorer in the long term. And that is the key phrase: long term.
Rather than dumping your (hopefully carefully researched) assets, revisit your valuation metrics and decide if your portfolio – whether it consists of stocks, bonds, commodities or cash – will withstand a crisis. Such as the Covid-19 market crash of almost a year ago.
No one foresaw it and the effects on portfolios were daunting. No investor, pensioner or saver was left unscarred. However, the jump back to normality – driven by low interest rates in well-off nations and subsequent high liquidity – was even more mind boggling. And unfortunately this rapid return to “normality” may give rise to an even worse notion: that today’s rocketing asset prices, underpinned by low inflation, will remain intact forever.
It belies quite fundamental questions, one of which is: Will governments in developed countries be able to service their debts, especially those bonds held by retirement savers? When these large chunks of demographics become pensioners in countries as varied as Japan, the US, Canada, the UK, Germany, Italy, Greece, the Netherlands and all of Scandinavia, will their governments be able to pay up? And, worse, will these countries be able to continue borrowing money without starting to print it, thereby fuelling inflation?
It is against this background of unease with today’s market valuations, enormous government debt, the Covid-19 crisis and possible future inflation, that finweek asked several fund management professionals for some perspective.
Fear of missing out
Stocks listed on the Nasdaq, an exchange laden with technology companies, have been in a multi-year rally since the second half of 2019
(graph 1). The Nasdaq Composite Index’s only notable snag in almost two years has been the Covid-19-induced market crash last year. But since then, the stocks have been tracking higher. A more impressive rally has been that of the cryptocurrency Bitcoin, where the NYSE Bitcoin Index speaks for itself (graph 2).
“The current global environment is very supportive of risk assets,” Jacobus Lacock, fixed-income portfolio manager at Fairtree
Asset Management, tells finweek.
“High levels of liquidity, pent-up household savings, decent balance sheets and improving labour markets will drive demand and asset prices higher. Add to this record-low interest rates, more fiscal support and continued asset purchases by central banks, and you get the perfect recipe for speculative behaviour.”
He uses the GameStop/Reddit episode, where day traders forced hedge fund managers into an expensive “short squeeze”, as one example of where retail investors were able to push market volatility higher. Lacock adds that the global fiscal support in response to the Covid-19 pandemic is going directly to consumers, whereas the support after the global financial crisis of 2008-2009 targeted financial markets. “As a result, we expect volatility to remain high and large equity market corrections from time to time, given elevated valuations in pockets of the global equity market,” Lacock says.
Pieter Koekemoer, head of personal investments at Coronation Fund Managers, has a similar sentiment: “It is clear that speculation has increased after the initial Covid19 shock of February and March 2020. We can add electric vehicles, an increase in initial public offerings [listings] of unprofitable technology businesses and the popularity of Spacs: special purpose acquisition vehicles that are able to raise capital with the intention of acquiring unspecified businesses in future, to the Bitcoin and GameStop examples.”
Even though government stimulus packages were targeted at the real economy, cash found its way into assets, which has led to some measure of speculation.
Duane Cable, head of SA quality at Ninety
One, says: “We have seen a growing disconnect between Wall Street and Main Street as markets continue to rally in the face of significant economic damage caused by Covid-19. The fear of missing out has caused some to abandon any defence in their portfolios and risk scoring a few own goals in the process.”
All that glittered
With a sudden evaporation of the so-called “risk-on” mood, when investors flock to riskier assets, gold has always been regarded as a safe-haven asset. Last year’s market rout was no exception. Bumper local gold-mining dividends attest to that.
Patrick Mathidi, head of equities and multiasset strategies at Aluwani Capital Partners, agrees: Gold – both the metal and the stocks – have “traditionally played the role of portfolio insurance in cases of extreme risks and volatility in financial assets”.
Stephán Engelbrecht, fund manager at
Anchor Capital, shares the historical view on gold as a hedge against market turmoil, but adds that other assets may now take over that role.
“More recently, the gold price has not reacted in the way that we would have expected,” he says. “It appears to us that cryptocurrencies may have stolen some of gold’s appeal.” (See also stories on p.22 and p.24.)
Suffice it to say that the dollar price of gold fluctuated between $1 451.55 and $2 075.47 an ounce over the past year to trade at around $1 788 at the time of writing. Since the beginning of the year, the metal’s price has declined by just over 5%.
On the other hand, the price of Bitcoin rose from around $8 000 at the beginning of 2020 to almost $51 000 at the time of writing. Bloomberg reported JPMorgan’s warning that, should Bitcoin’s price volatility not recede soon, it may start to give back some serious gains.
Nevertheless, there are some who still hold on to gold as a hedge. Says Bradley Preston, joint managing director of Mergence Investment Managers: “While currently out of favour, we think exposure [to gold] offers a hedge in many risk-off scenarios.”
Amid these conflicting signals in the market, local fund managers are of one voice when it comes to investing: Do not get caught up in the euphoria. And do your homework on each individual asset you consider buying.
finweek has asked several fund and investment professionals to share their strategies with regard to the current markets. Approaches do differ though, and we will look at each asset class separately with their aye− and naysayers.
Ntsekhe Moiloa, head of multi-asset at Vunani
Fund Managers, says that it is hard to make a case for keeping your capital in cash, due to the dearth in returns, other than for its deployment into “opportunities when prices have retreated”. That, he says, means scanning the equity markets for names with relatively “good balance sheets, industry leadership and scope to sustain earnings growth even in a subdued economic climate. In short, we are looking for quality companies.”
Aluwani’s Mathidi says there is value in domestic equities, especially when they are
compared with their own histories. “However, we are concerned that there isn’t sufficient earnings growth to come, given the lacklustre South African GDP growth projections,” he says.
To allay this risk, Mathidi’s portfolio has a bias towards quality stocks. “We like stocks that have low debt and are highly cash generative, still gaining market share and expanding their net operating margins and are poised to do relatively well irrespective of the external macro [economic] outcomes.”
He highlights Motus, the car retailer which was spun off Imperial a couple of years ago. “In addition to the [initial] criteria, the company is benefiting from the migration of car buyers from high price points to entry-level and midpriced passenger vehicles.”
Roy Mutooni, an equity analyst at Absa
Asset Management, says that foreigners, who have been returning to the local stock and bond markets since January, have been showing interest in their trusty favourites, such as Clicks and Mr Price, among others. “Outside these, there remain many opportunities for South African investors: stocks that were sold off, but not have rallied back as much and which continue to offer value from a fundamental perspective.”
These include, Mutooni says, companies, such as Super Group, Italtile, KAP Industrial Holdings, AfroCentric, Sea Harvest and Adapt IT, which all have “solid balance sheets, management that have navigated the weak macro economy and emerged with higher market shares and improved fundamentals”.
On the other hand, Ninety One’s Cable says that while valuations are looking more attractive, the prospects for many SA-exposed companies, so-called SA Inc. businesses, remain dependent on a local economic recovery.
“Unfortunately, the timing of this recovery is incredibly difficult to forecast given the ongoing uncertainty around Eskom, continued job losses, regulatory uncertainty and low business and consumer confidence.”
He may have a point. According to Stats SA figures, SA generated 5.2% less power in 2020 than in 2019. And the official unemployment rate stood at 30.8% in the third quarter of last year, with 14.6m people employed out of a total population of 59.6m.
The RMB/BER Business Confidence Index, which has not risen above 50 out of 100 points since the last quarter of 2014, crawled back to
40 in the final quarter of last year after crashing to five at the height of the Covid-19 lockdown.
And although the FTSE/JSE All Share Index is trading at record or near-record highs, it has been largely moving sideways over the last five years (graph 3).
Raphael Nkomo, head of strategy and
research at Ngwedi Investment Managers, is more adamant about the valuation of stocks in general. “From a positioning standpoint, we are trimming back our equity exposure and de-risking the multi-asset class portfolios, as we are increasingly convinced that the equity market is running ahead of itself too soon and too quickly.”
Commodities and miners
Local miners, however, are coining it as an increased demand for metals is driving commodity prices. An example is the miner of gold and platinum group metals (PGMs), Sibanye-Stillwater, with its almost R30bn in expected profit for the year ending December 2020. It made R62m profit in 2019. For example, the price of rhodium, used to limit noxious gases in vehicle engines, has almost doubled over the last five years, gaining about 88% over the past 12 months.
Says Anchor’s Engelbrecht: “For investors wishing to enter the market, we believe that the platinum group miners are still offering a very attractive risk-return profile. The continued focus on the environment and the ongoing drive to reduce carbon emissions, will drive the demand for PGMs.”
These companies are trading at attractive
valuations and have strong balance sheets, which can protect them against extreme turns in the markets if the global operating environment changes suddenly, he says.
Vunani’s Moiloa is also positive about the prospects of mining stocks, especially the longevity of this performance. “Given the global backdrop, we think the strength in resources counters might surprise in terms of its length, so we are comfortable to hold those names.”
South African government bonds had a rough 2020 – first being downgraded to junk status and then dumped wholesale by index-trackers and investment-grade mandated funds just as the Covid-19 pandemic struck. The spike in yields across the curve (remember that the price and yield of a bond are inversely related to each other) led to a steep risk premium demanded by investors to hold SA government debt.
This resulted in a feast for income funds, that suddenly realised yields upward of almost double consumer price inflation. The situation has, however, now started to normalise.
One fund manager that is on cloud nine due to this dynamic, is Gryphon. With the bulk of its balanced fund’s holdings in bonds and cash, the fund is on its way to benefit from the full rerating in local government bonds – that is basically buying when everyone dumped them and now holding on as the price increases.
“The fund’s holding in local long-term bonds and cash allows us to benefit as South African bonds rerate,” says Reuben Beelders, manager of Gryphon’s balanced fund. “Furthermore, should equities offer value in the future, this very liquid asset class can easily be sold.”
And it does not look like they will be shifting allocations soon. “We believe that at current levels, financial markets are priced for perfection and perfection is seldom achieved,” says Beelders. “It is mostly only a perception, not reality.”
Bastian Teichgreeber, chief investment officer of Prescient Investment Management, also acknowledges the elevated risk premium on local interest-bearing assets. “We prefer to be exposed to exactly these risky assets where risk premia remain elevated and where we see room for compression of such. SA bonds, SA preference shares or the rand would be the best examples.”
Ngwedi’s Nkomo says their multi-asset portfolios are pivoting away from stocks. “This tactical exercise allows us to lock in gains following the significant upward move in equity prices while increasing our exposure to SA bonds that continue to offer attractive yields at the long end [those with a long maturity].”
Ninety One’s Cable says: “The best local opportunity remains government bonds which provide a real return in excess of 5%, which is attractive relative to historical real return expectations for bonds of between 2% and 3%.”
A local sector which attracts less enthusiasm is the listed property sector. “We are currently staying away from property stocks, especially those that are materially exposed to super regional shopping malls and office space,” says Aluwani’s Mathidi. “We believe that sector of the market will face structural headwinds for some time still.”
The sector’s declining fortunes, worsened through vacancies as businesses closed and rentals were reduced, were driven by what Cable refers to as “expensive valuations, excessive gearing and unsustainable dividends”. He says: “We believe the prospects for local property are too binary given our bottom-up forecasts and do not believe they offer attractive risk-adjusted returns.”