Equities warrant selective buying

On the back of recent events, the South African stock market has fallen by 35% in rand terms and by almost 60% in US dollar terms. This is the biggest twelve month dollar correction since at least 1960. As a result, equities have become relatively more attractive and warrant selective buying, says Heaton van der Linde, joint head of Allan Gray Institutional Client Services.

As an open economy, South Africa has not escaped the knock-on effects of the recent market turmoil. Businesses, the government and consumers have all been affected.

Falling commodity prices affect South Africa’s balance of payments, the value of the rand and inflation. The real growth rate in GDP could therefore disappoint. This will place corporate earnings under further pressure and exacerbate what may have been a ‘normal’ correction of company earnings through a business cycle.

“We have cautioned investors for some time that we believed aggregate earnings on the All Share Index (ALSI), having grown at unprecedented rates during the past five years to record highs in late 2007, were unsustainable,” says van der Linde.

He says this was true for most sectors. Financials and industrials were driven by a buoyant consumer and the resources sector was driven by record commodity prices on the back of a global consumer and investment surge.

However, the stock market is a discounting mechanism and sharp corrections have already been seen in many share prices as investors begin to factor in the prospects of substantially lower earnings, he says.

“It has become obvious that most of the global boom was attributable to asset price inflation and a process of leveraging up rather than any fundamental or structural issues. Falling asset prices have, and will continue to result in a painful process of de-leveraging that could last a number of years.”

Van der Linde says that even before recent events, Allan Gray had invested in companies that it felt were relatively defensive, many of whom generate a substantial portion of their earnings offshore and which would most likely be able to maintain and grow their earnings in real terms over the next four years.

In terms of fixed interest instruments, the firm holds a very conservative, short-dated fixed interest portfolio. “While food and oil prices have abated from their highs earlier this year the significant weakening of the Rand together with double digit wage and salary increases is likely to continue to prevent inflation from returning to its target in the near term,” van der Linde concludes.