Friday 28 August 2020 marked day 154 of lockdown in South Africa, albeit a lighter, easier lockdown than the hard lockdown of March and April. And while South Africans are revelling in the easier access to restaurants, smokes and booze, they are feeling increasingly anxious about the country’s future prospects.
So just what is the lie of the land, and how does it shape your investment decision making?
The Covid-19 pandemic has accelerated structural trends and triggered fiscal and monetary policies on an unprecedented scale. As a result, the low interest rate, low-growth and low inflation environment will persist well into the future.
The IMF is forecasting a 4.9% contraction in global output due to the coronavirus with global economies only expected to recover by late 2022, and that is if a vaccine is available.
Globally the likely long-run effects include a huge loss of small businesses and human capital; more permanent telecommuting; acceleration of digital transformation; increased concentration and decreased competition in some sectors.
In South Africa, which faces its own unique economic challenges, GDP is expected to contract by between 7% and 10% in 2020. The country is facing a fiscal (and political) crisis and although global growth is an important factor, it is primarily domestic fiscal policy measures and implementation of economic reforms over the next six to 12 months that will determine the growth trajectory over the next several years.
What does this mean for markets?
With central banks providing a backstop, and with little competition from the miniscule yields on bonds, the recovery in US equity markets in the midst of the pandemic is a hot topic.
The rally in the benchmark S&P 500 equity index, whose 55% rise since March 23 to an all-time high in late August marks the fastest-ever recovery from a bear market and confounds economists who wonder if markets are divorced from reality.
But it’s dangerous to assume the entire market is rallying. It’s not. In fact 63% of the 505 stocks on the index (which tracks the largest companies in the US) are down, according to CNBC.
The shares of companies that facilitate working, shopping and playing at home – the tech stocks - surged while those dependent on people being out and about are still well below pre-pandemic levels.
On the other side of the Atlantic a different story is playing out. The UK’s FTSE 100 peaked at 7 859 points in May 2018. Today its sitting at 5 963, a level it first breached in 1999. That is two decades of going nowhere.
Sound familiar? In Johannesburg the JSE All Share’s record of 61 684 set in January 2018 feels like a distant memory.
Old Mutual investment strategists Dave Mohr and Izak Odendaal point out that this trend plays out across the globe.
The French CAC 40 Index, currently around 5 000 index points, peaked in 2000. Australia’s ASX 200 Index surpassed its 2007 peak in mid-2019 year and set a new record in January of this year. But it is still 14% below this point. MSCI’s Emerging Markets Equity Index is still below the 2007 record when measured in dollars. The biggest laggard by far is Japan’s Nikkei 225, which might never retest its 1990 record of 38 915 points, and is currently languishing at 22 865 points.
The point is, despite all the talk of market correction, markets – arguably with the exception of the US tech market – are far from bubble territory. So while there is no rising tide, there are opportunities for stock pickers who are willing to do the research.
In the UK for example, equities, hammered by the long-winded Brexit transition followed by the COVID-19 lockdown, are attractively valued and could be offering opportunities.
With equities under pressure, it is perhaps no surprise that JPMorgan analysts recently estimated that non-bank investors with mixed asset portfolios are currently allocating just 41% to equity.
If that’s the case what else should investors consider?
Value is emerging in the listed property sector, for the first time in a long time, and the team at Old Mutual Multi Managers is cautiously allocating capital to certain counters. In particular they favour foreign real estate, believing that the local listed property companies will continue to face a challenging period.
The price of gold hit a record high, first at $1 976/oz at the end of July and again at $2 000/oz on August 4. While the price has come off fractionally gold is still seen as a safe haven in a tempestuous world.
Dr Adrian Saville and Kyle Ferreira, CEO and investment analyst at Cannon Asset Managers recently suggested that currencies themselves offer a source of diversification. The oil-heavy Norwegian krone, for instance, behaves differently to the industry-based Swiss franc; and they each behave differently to the US dollar. When things are tough in energy-based Norway, things could be fine in pharmaceutical-exporting Switzerland; and your “drugs and oil” portfolio will earn in dollars as the global default currency.
As with other asset classes, combining non-correlated assets into a portfolio creates diversification which means you can achieve the same investment outcome with lower volatility.
This is particularly pertinent when you consider that since late March the US dollar has fallen almost 10% against a basket of other currencies around the globe. Some of this selloff may have to do with the fact that the dollar shot up so much at the outset of the crisis, as people saw the dollar as a safe haven. But some investors are now wondering if this is a sign of a long-term trend reversal.
China’s management of the Covid-19 crisis allowed its economy to recover more rapidly than many other nations. The Chinese economy now represents 16% of gross domestic product globally. However, this is not yet reflected in the world’s financial markets, says Stéphane Monier, CIO at Lombard Odier Private Bank.
China is in the process of being added to a number of benchmarks and currently accounts for just 5% of the world’s equity markets and 5.3% of the value of the Bloomberg Aggregate Global Bond Index, for example. Investors could consider making a specific portfolio allocation to this enormous, and growing, market.
On the home front
It can be difficult to mount a compelling investment case for SA equities. At times the challenges feel overwhelming with deep structural impediments to growth, unemployment, and depressed aggregate demand weighing on earnings.
Headwinds are undoubtedly large and enduring but Mohr and Odendaal note that there are also some positive macro fundamentals to consider - for instance interest rates and inflation rates are at historic lows, creating a stimulatory backdrop. Indeed, history suggests that pervasive gloom is often a necessary pre-condition for being able to buy attractive franchises at attractive prices.
Companies with particularly noteworthy attributes include AB Inbev (global brewer with temporary headwinds, yet listed on the JSE), Discovery (highly defensive cash flows from core health and life operations and temporarily obscured growth) and the JSE Limited (cash-flush exchange with revenues benefiting from elevated volatility).
Smaller companies such as Raubex, WBHO and Afrimat stand to benefit from reduced local competition as competitors fall by the wayside due to tough local conditions. Many shares are now pricing in exceptionally low expectations far into the future.
Last but not least - SA government bonds
Yes there are risks to SA government bonds, but they are not as risky as the headlines suggest. The exceptionally high income yields they offer have resulted in an asymmetric risk profile that is likely to offer investors equity-like returns over the next few years. By contrast, the corporate credit sector is thinly traded and illiquid, and remains vulnerable to a repricing if liquidity starts to dry up.
For all our problems here in South Africa, global market conditions will dominate domestic financial markets. For the most part, the outlook for rand, the JSE and bonds depends on global risk appetite. Local asset classes offer value and, with a supportive global backdrop, can deliver real returns.
That said, it’s not loyalty but diversity - of geographies and assets – that is your friend.