Small players set for year of the bull
Analysts say smalland mid-cap shares could outdo big boys
● The JSE All Share index ended 2017 on a high — closing 16.63% stronger after breaching the 60 000 level for the first time during the year. While it is unclear if this year will yield the same for investors, some analysts are pinning their hopes on small, domestically focused companies.
Despite the fall in Steinhoff’s share price just weeks before year-end, 2017 was dominated by the Top 40 shares such as Naspers and Richemont. Naspers’s share price doubled before closing the year almost 70% higher, while Richemont’s share price saw growth of 24%. Some portfolio managers think the pace of these gains is unlikely to continue.
For the year ahead a number of portfolio managers believe small- and mid-cap shares could shine if the local economy continues to improve after the recession last year, and if the government implements policy changes.
AlphaWealth fund manager Keith McLachlan said he expected it to be a good year for the JSE as the election of Cyril Ramaphosa as ANC president indicated that South Africa was “politically self-correcting”. In addition, investor sentiment had started coming out of the trough it had been in and was likely to improve further this year.
“Given the fact we are coming off a couple of tough years for small caps, and as the valuations are generally low, [even] a small uptick in these variables could relate to quite a nice movement in terms of share price.”
Strong rand
McLachlan said it was likely that small- and mid-cap stocks would outperform the Top 40 this year because the Top 40 was dominated by a handful of companies that tended not to do well with a stronger rand.
This week the rand surged to R12.23/$, a level not seen since mid-2015, but it weakened on Friday to R12.36.
McLachlan said he was looking at companies that had “a good concentration in South Africa” and a low valuation, such as Blue Label Telecoms, Hosken Consolidated Investments and Advtech.
Portfolio manager Wayne McCurrie at Ashburton said South African industrial, retail Picture: TBG Archive
and financial shares would do “reasonably well” in the year ahead if the economy improved, the rand remained strong and inflation was contained.
He said big rand-hedge stocks like Richemont would probably deliver moderate returns while Naspers was likely to perform well, barring any changes to the status quo in China where Tencent, in which it has a 34% stake, is based.
McCurrie said financial services stocks would benefit from the rosier political and economic outlook. His picks would be Standard Bank, FirstRand and Sanlam, while industrial shares like Bidvest could do quite well.
And despite some bad news associated with EOH, McCurrie said its strong earnings could lift its share price. Last year a director of three businesses owned by the group had his home searched in a probe of alleged corruption in government contracts.
Andrew Joannou, a portfolio manager at Investec Asset Management, agreed that industrials were poised to perform well.
Grindrod, which was doing “interesting things” regarding shipping and port utilisation, was unbundling later this year, he said.
Adcorp was another of his picks. The group had “a bit of bad year” in 2017, partly due to changes to labour law that derailed demand for outsourced staff.
But Joannou said Adcorp could continue to deliver earnings after making changes to the business, and if employment picked up on the back of a better economy.
He said he also expected resource shares like Pan African Resources and Impala Platinum to gain ground because they had not responded yet to the uptick in commodity prices. On the downside, Joannou said the market had “priced in perfection” in certain stocks like AVI, Clicks, Dis-Chem and Mr Price and these were unlikely to strengthen further even in a positive economy. McCurrie said a number of domestically oriented shares were undervalued and could deliver double-digit growth, but it was unlikely that the All Share index itself would perform that well.
He said last year was exceptional — Naspers provided a “massive performance”, heavyweight resource shares did very well towards the end of the year, and financial stocks had not disappointed.
“Going into the new year under a good South Africa environment, I can’t see — even though I’m not negative on resources — they can do the same again.
“And you would think that Naspers wouldn’t double again, so your outlook for the All Share has got to be low single digits,” he said.
Domestic politics
Joannou said the big question was how domestic politics would play out and what impact that would have on credit ratings and the budget. Last year S&P Global Ratings downgraded South Africa’s long-term local currency rating to junk while Moody’s placed South Africa on review for a downgrade in 2018.
He said a lot of the “good news” expected from Ramaphosa has been priced in, based on the expectation that he would initiate policy changes that could avert a further ratings downgrade.
But if he failed to do so in the first quarter then the stock market rally would be short- lived.
Joannou said that “global-growth sensitive” shares had benefited from economic strength in Europe, the US and China and stronger commodities prices.
“Commodity prices are looking pretty healthy and I think that a lot of those prices aren’t quite factored into the earning expectations of a lot of the resources shares,” he said.
“So I think they are going to be getting some sort of positive earning revisions . . . but a very important factor is that the global growth story does not deteriorate.”
Goldman Sachs sees global growth of 4% in 2018. JPMorgan Chase & Co forecasts 6.7% growth for China this year, according to Bloomberg.
Joannou said that while global growth was looking “pretty good”, caution should be exercised.
“There are no storm clouds on the horizon, but I think markets have run pretty hard and the bull market is one of the longest globally we have ever experienced,” he said. “So while there’s nothing obvious [to dampen the market] I do think a little caution is warranted.”