Times are tough, but we’ve been here before

Peter Linley, Fund Manager of the Old Mutual Investors’ Fund.

With concerns around the country’s current uncertain political and economic outlook intensifying, markets are bracing for a possible sovereign downgrade. While a downgrade will not be good news for the South African economy, in a number of instances the financial markets appear to already have discounted the event in prices.

This is the view of Peter Linley, Fund Manager of the Old Mutual Investors’ Fund, presenting at a media roundtable in Johannesburg today, which marked the 50th anniversary of the Fund.

“The potential negative effects of a downgrade are making the market nervous and this, coupled with the current uncertainty, has resulted in some assets already pricing in the worst outcome,” says Linley. “This provides opportunities for investors, provided a longer-term time frame is considered.”

Short-term events have impacted the market regularly over time and the last 50 years of the fund’s existence is no exception, says Linley. “Despite seven bear market cycles – as calamitous as they may have felt at the time – equity markets have trended upwards over the long term,” he explained.

In 1966, at the inception of the Fund, the JSE traded at 116; today it trades north of 50 000. Linley ascribes this to the free market and the ingenuity of company management to continually adapt businesses in spite of challenging circumstances. “The right incentives encourage companies to take on risk in the challenge of maximising returns for all stakeholders,” he says.

Linley refers back to when the fund was launched. “Much like the current environment we find ourselves in today, 1966 was a volatile time for South Africa. The Prime Minister, Hendrik Verwoerd, was assassinated in parliament and the country was facing an uncertain future. But, this backdrop also presented opportunities.

“The Investors’ Fund’s 50 years performance record is evidence of the influence that acting upon these opportunities can have over the long term.” To illustrate in practical terms, Linley points to the example that if a person invested just R339 in the fund when it started, they would have R1million today.

He does, however, caution that the local market is impacted by global macroeconomic forces at play. “The global economy is growing below its long-term real average and we are concerned that the nominal rate is close to stall speed. We cannot afford for the low level of inflation to move into deflationary territory. This will have negative consequences on growth and employment”, Linley says.

“High debt levels globally also remain a concern, although we are now seeing some deleveraging in the developed world. Debt in the emerging economies continues to expand, but at a slowing rate. Coupled with this is the low level of demand and excess capacity in the global economy as is reflected in the negative output gap.”

Linley points to China, a large global growth driver, which has been shifting from an investment-led economy to a consumer-focussed economy. “We have been cautious on Chinese growth for the last few years and are not yet convinced on the sustainability of the recent acceleration in economic activity,” he says. “The extraordinary growth we saw in the first part of the decade was a once off and will not be repeated. That was a boom time for commodity prices, which have now fallen to very low levels. And while the macro environment presents challenges and risks for commodity prices, the possibility of prices reverting to mean over time does look attractive.”

Linley also highlighted that Gold recovered this year from highly oversold levels, sparked by the US Fed implying that interest rates would stay low for longer than anticipated. But the link between gold and the US dollar was maintained this year as gold rose on the back of the US dollar weakening. “While we like gold as a form of insurance in the portfolio, the major driver is a weaker dollar and we do not expect much dollar weakness in the short term.”

Turning to the South African rand, Linley says that the currency looks undervalued, but headwinds remain in the form of political uncertainty and lack of confidence, low global growth, labour inflexibility and fiscal and current account deficits, which remain high relative to most other emerging markets.

“While we reduced our rand hedge exposure in the portfolio at the beginning of the year, we still favour shares that will benefit from a weaker rand. Despite the fact that the Fund only invests in shares listed on the JSE, we are still able to access companies with significant offshore earnings,” he explains.

These shares include Naspers, British American Tobacco, Anheuser-Busch, Steinhoff, Aspen, Bidcorp and Mediclinic. “Naspers, in particular, continues to offer attractive value despite its stellar performance over the years,” says Linley. “We don’t see much value in the South African-focussed consumer shares despite the quality of many of these businesses. On the other hand, the local banks, including Barclays Group Africa, which have been poor performers over many years, are now trading at prices which discount more than their fair share of bad news.”

Looking forward, Linley says the low level of interest rates globally is expected to remain supportive of the equity market despite it not looking cheap. “This, coupled with the fact that the dividend yield on many South African shares is higher than many developed market bond yields, should continue to attract the interest of foreign investors in the JSE,” he concludes.