Category Investments

Inflation dominates the onshore, offshore equity debate…

23 November 2021 Gareth Stokes

The decision to remain ‘long’ global and offshore equities, and the specific sectors and shares you should be choosing, could be functions of your view on US inflation. As 2021 draws to a close, asset managers seem to be in one of two camps, with some seeing inflation as a genuine systemic problem, and others arguing that it will prove transient… “US Inflation might endure for a bit longer due to supply chain issues such as the well-documented computer chip shortage; but ultimately, it will not be a problem,” said Chris Freund, co-manager at Ninety One Equity Fund, during a panel debate at the 2021 Morningstar Investment Conference.

US rate hikes only expected late in 2022

In this context, the US Federal Reserve is only expected to raise interest rates in the fourth quarter of 2022, with a gentle hiking cycle through 2023 and 2024. Freund expects robust economic growth in the fourth quarter of 2021 and throughout 2022 as the global economy gradually emerges from pandemic. “We think equities will outperform other asset classes under these conditions, but with more periodic setbacks that will test investors’ mettle,” he said, adding that the so-called ‘easy money’ generated from equity portfolios post the March/April 2020 collapse was a thing of the past. 

Chantelle Baptiste, a senior equity analyst at Fairtree, took a different view on inflation. “We are more in the permanent inflation camp and are taking a cautious view on US inflation,” she said. “US housing prices and homeowners rentals are going up significantly, and there is a certain ‘tightness’ in the US labour market”. Other macroeconomic concerns that influence the asset manager’s asset class selection include geopolitical tensions between China and the West, and the continued polarisation of communities within countries. As example of the latter, Baptiste pointed to the political landscape in the US: “The middle ground, the conservative rational voice is muted; so the extreme left and extreme right have become very noisy …  in the US, you are either very Democrat or very Republican”. 

Opportunities in South Africa Inc

Sean Neethling, a portfolio manager at Morningstar, and moderator of the panel discussion, interrogated panellists on the outlook for South Africa equities. “The South Africa Inc story is an interesting one,” said Sean le Roux, a portfolio manager at PSG. “There are fantastic businesses in South Africa, and every now and then they go on sale”. He pointed out that many JSE-listed firms had been in a protracted bear market pre-pandemic, which made the local bourse an excellent hunting ground for value-based stock pickers. These firms bled value in March/April 2020 but have since bounced back to deliver stellar returns. 

According to Baptiste, local shares were selected based on their potential to generate return rather than whether or not they fit into a South Africa Inc basket. “We go where we can generate alpha, if South Africa Inc will give us that, we will be there,” she said. During 2020 and 2021, the asset manager saw potential in the industrial and retail complex, with a standout performer being MTN. More recently, the focus has shifted to include opportunities in the resources sector and taking larger stakes in Naspers/Prosus. Freund, meanwhile, was starry-eyed about the return potential in South Africa’s banking sector. “You could close your eyes and buy any of the big four banks [you can include Capitec and Investec as well], and come back in 24 months with a 10-15% per annum return, including dividends,” he said. 

On China, concentration risk and insane valuations

Baptiste’s comment about increasing exposure to Naspers triggered a debate within the debate. “We do not own the share, and we are some way off pulling the trigger on it; this offers a classic example of the selective application of ESG factors in portfolio construction,” said Le Roux. He pointed out that governance risk was elevated due to Naspers’ massive exposure to China-based Tencent, and the pressure on management to be “beholden to the whims” of the Chinese political system. Simply put, Naspers is too pricey to compensate for this governance risk. Concentration risk is also an issue. “As a consequence of significant crowding and consensual positions, [we see this share] at between 10% and 20% of every South African equity portfolio … and that is absurd,” he said. 

China is South Africa’s largest trading partner and the largest consumer of commodities globally, and could prove quite influential in how financial markets perform, whether locally or offshore. “With their property market mildly imploding at the moment, it is obviously not great for resources,” said Baptiste. “Anything that has exposure to China is going to be volatile over the next 18 months; but if you can stomach that, and you can see through it, there is probably a lot of money to be made”. 

Some thoughts on share selection

How should one invest in equities going forward? US equity valuations have been heavily skewed by the long duration low interest rate environment and unprecedented monetary policy and fiscal stimulus in that market. The result is that many shares are sitting on staggering price-to-earnings ratios… “We are avoiding the elevated parts of the market that are trading off global interest rates,” said Le Roux. “I can give you a long list of companies that are well under 10 price-to-earnings; these are companies that should grow faster over the next 10 years”. 

According to Freund, investors must acknowledge the risks of systemic inflation in the US, which could prove damaging to global equity markets. Dollar-based commodities should do well under this scenario. But investors should also consider the possibility of a global recession, which will prove damaging to South Africa Inc shares.  Under this scenario, said Freund, “the dollar will get stronger and all emerging market currencies will go weaker … which means you will want a portfolio filled with rand hedges such as Anheuser-Busch, British American Tobacco and perhaps Bid Corp”. He concluded that global recession and systemic inflation, although not part of the Ninety One house view, were tail risks that the asset manager was monitoring closely. 

Writer’s thoughts:
We have long followed the SA versus offshore equity debate, with one of the frequent criticisms being the dwindling investible universe on the JSE. And it seems, given recent de-listings, that this investible universe continues to shrink. I would love to hear what financial planners, IFAs and investment advisers think about the long-term prospects of SA-only equity portfolios. Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts ed[email protected]

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