Equity investors are having a tough time and it’s not over yet
But diversify and look at stable global stocks, advise analysts
VOLATILE global markets, uncertain emerging markets, a slowdown in the Chinese economy, currency fluctuations, the list goes on and on ... suffice it to say, it’s been a rough ride the past few months for equity investors.
The past quarter was one of the worst periods of the past four years as far as risky assets are concerned. In fact, points out Urvesh Desai, portfolio manager at MacroSolutions, Old Mutual Investment Group, emerging market currencies have not experienced a worse period since the 1998 crisis.
He argues that, contrary to popular perception, it was not the yuan’s devaluation that set off the crisis. Markets were already nervous, and the yuan was merely the straw that broke the camel’s back.
“After the global financial crisis [in 2008] we saw a brief rebound in global earnings, but since 2011 these have been largely flat in US dollars for a long time. Even the US, which was the sole region with positive earnings growth, turned negative at the start of this year,” says Desai.
Volatile markets trading at elevated valuation levels — despite market corrections in the past weeks — have not provided the opportunities you would expect, says Sumesh Chetty, portfolio manager at Investec Asset Management. He predicts the market will become even more volatile in the months to come and says investors who own equities need to be careful.
“We’re very much a resourcebased economy, driven by global markets.
“Traditionally, China has been a driver of the demand for our resources and as that economy has slowed down, it’s negatively impacted our resources sector,” says Chetty.
“The result is that our resource sector is currently priced for Armageddon.”
But why the mass panic just because the market is perceived to be more volatile than usual, questions certified financial planner Gregg Sneddon.
“Market volatility is not something new or unusual — the reality is that they’re always unsafe and always volatile. After several years of good returns, we’ve just forgotten how risky the markets really are.”
He points out that if you’re planning to invest in equities as an asset class, you need to accept that in any given 12 months there is a (roughly) 20% chance of a negative return — and if you want equity returns, you need to be able to take equity risk. Diversification, he argues, is the key. “At some point in the future, the pendulum will swing again. You need to be patient: equity investing is not a sprint, it’s a marathon, and you haven’t lost anything until you’ve sold.”
It’s not all doom and gloom for equity investors, however.
Chetty maintains there are still good equity opportunities — businesses that are less reliant on the global economy and will continue to do well irrespective of economic volatility. These are typically stable businesses that generate positive earnings throughout the cycle. A good example, he says, are companies such as SABMiller, Richemont and British American Tobacco.
“We’re seeing that investors are choosing to disinvest in businesses that are most impacted by uncertainty and dependent on macroeconomic indicators. Instead, they’re buying equities and stocks in businesses that will continue to hold their own and generate a profit come rain or shine,” he says.
“I’m not suggesting that SAB is necessarily a good option right now after their recent 20% price increase, but BAT, certainly, offers good opportunities currently.”
There are two issues that need to be taken into consideration before investors decide to hold or sell their equities, says Northstar Asset Management analyst Adrian Clayton. One is time and expected returns — what period of time is reasonable
The result is, our resource sector is currently priced for Armageddon
when deciding on investing in equities and what returns should be expected. The second is value versus price. In other words, how stocks are priced versus what they are really worth.
“When equities are the asset class of choice, periods of less than nine years heighten the risk of disappointment when real returns are the target,” explains Clayton. “Our analysis has shown that all fiveyear rolling periods over the past four decades have resulted in the JSE producing positive nominal returns, but not necessarily positive real returns — that is, taking inflation into account.”
When it comes to equities, ideally you need to take a long-term view, maintains Desai. “South African equities can still not be considered to be in cheap territory comparing them to history. With the latest correction, there are pockets of value developing, for instance in the resources and construction sectors, but there is significant risk associated with these as they are operating in deteriorating environments.”
According to Desai, given where global equity markets are, valuations are expensive but manageable. He argues that South African equities are sitting at really high valuations. “When you combine this with inflation, a sluggish economy, a weakening currency and falling commodity prices, South African equities start to look less attractive, which is why we’re currently favouring global equities.”
He stresses that this is not a rand call, but an opportunity to invest in markets with improving environments such as Europe and Japan. “The macro data coming out of both of these regions is positive with less risk associated.”
While emerging markets offer cheaper equities, these markets are more risky now due to their reliance on easy US monetary policy, China and commodity prices, he says.
“When we consider our options globally, equities are the best place to invest in if you want to see real returns over the long term. There’s some indiscriminate selling of both good and bad shares, which not only is a good indication of the sentiment in the market currently, but offers opportunities to astute investors.” DIFFERENT VIEW: Urvesh Desai, portfolio manager at MacroSolutions WARNING: Sumesh Chetty, portfolio manager at Investec Asset Management
After several years of good returns, we’ve forgotten how risky markets really are
Despite the decline in the market, Clayton believes there are still overvalued equities. Northstar conducts a detailed analysis of every business it considers investing in. “Stock after stock that we undertook this detailed work on during the second half of 2014 and into 2015 had share prices above what we calculated the company to be worth,” he says.
“Very few South African companies looked fairly priced and if an investor sought a real ‘margin of safety’, this was sorely missing. To an extent, this changed for some listed companies as the market started selling off midway through 2015. Those companies that have made it onto our buy list are very stock-specific, as opposed to the market offering broad-based value or value being applicable to any specific sector.”
He adds that they are still finding that most dual-listed South African stocks, most consumer stocks and many industrial companies are still trading above what they deem to be fair. In his opinion, however, a number of financials, particularly the banks, are trading below fair value and offer opportunities.
There are segments and companies on the JSE that Clayton says will come under severe pressure in the months and years ahead, whereas others should do rather well. “The key is to do proper research and get to grips with the value on offer versus the price you pay, because these are not one and the same,” he stresses.
Desai’s advice to investors is not to panic despite the market’s volatility. “You’re going to have a smoother ride if you choose a multi-asset fund to invest in. Because of the diversification, there is usually less risk associated with these types of funds.”
Avoid exposure to more risky sectors, advises Chetty — which means investors should avoid buying the index. “Any investments you make right now should favour less risk rather than more risk, given the volatility of the market,” he urges.
“Investors need to be selective: there are certainly stocks that I’m still very comfortable owning, but others are just too risky at the moment, so you can’t buy indiscriminately.”