A top global investment may be on JSE
CLIMBING IN: INVESTORS ARE FINDING THIS COMBINED OPPORTUNITY SET EXCITING
Some excellent and highly resilient companies offer increasingly attractive valuations.
Across the world, stock markets are seeing an extreme and unusual divergence. There are certain regions and sectors that are highly in favour and therefore richly priced, while others are severely out of favour and looking cheap.
PSG Asset Management chief investment officer Greg Hopkins explained: “For instance, the difference in valuations between the S&P 500 and emerging markets is the highest on record. The difference between the most expensive and least expensive parts of the US market is the highest it’s been since the 1950s.
“And if you look at South Africa, there is a subset of shares where valuations are lower than they were in 2008 and 2009 [after the global financial crisis] and 2002 [after the dot-com crash].”
Predominantly, these stocks can be found in the mid and small-cap sectors on the JSE. Traditionally, mid and small caps have outperformed the Top-40, but this has not been the case in recent years.
The underperformance of small caps has been particularly dramatic, with this part of the market showing a negative return over every period up to three years.
Extreme valuations
Morningstar Investment Management portfolio specialist Eugene Visagie said: “What has happened over the last three years is that mid-caps have considerably underperformed large-caps. And that gap has widened quite considerably.”
This is meaningfully out of line with the longer-term picture. Over 10 and 20 years, mid-caps have outperformed. This recent weakness is a distinct anomaly.
A major reason for this is that sentiment towards this part of the market has grown negative, as many mid-cap companies are highly exposed to the SA economy. Given the weak local environment, investors are extremely cautious.
However, there are some resilient companies that have been sold down heavily and are offering increasingly attractive valuations. They include the likes of fast-moving consumer goods group AVI, retailer Italtile and financial services businesses RMI Holdings and Santam.
There are also other mid-cap companies that have experienced difficulties and are now trading at more extreme levels, like leisure group Tsogo Sun, forestry and paper company Sappi, asset manager Coronation, and chemicals group AECI.
A number of investors are now finding this combined opportunity set exciting.
“Mid-caps are probably one of the most stand-out opportunities from a global perspective,” Hopkins argues.
Playing out
Even though the local environment is weak, some analysts argue that the valuations are so undemanding that the prospects for future returns off these levels are attractive. Loftie Botha, portfolio manager at Momentum Investments, points out: “The median forward price-to-earnings (P/E) of all the stocks on the JSE with consensus forecasts is 10. However, the median of their historical P/Es is 14. That means a 40% upside.”
“The market has been very disappointing for a very long time and even if sentiment only partially improves we could have a very attractive market and then mid and small caps should outperform,” Botha says.