A dramatic Q2 – not only for Greece and China!

Patrice Rassou, head of Equities at Sanlam Investment Management.

Investors’ faith in the ability of governments to engineer a soft landing for global financial markets was shaken this quarter with Europe and China experiencing acute volatility.

Drama in Greece

A Drachmatic Greek tragedy unfolded at the end of the quarter when the small EU nation could not service its debt obligations to the IMF (it owes four times more than all previous overdue debts from borrowers combined) and opted for a referendum to decide whether to continue obeying the terms of the European Monetary Union. A resounding No vote has led to Greece teetering on the brink of insolvency, despite having debts which are half those that brought down Lehman Brothers in 2008. Yet this should be no surprise to students of economic history, as Greece has defaulted on its sovereign debt on four previous occasions.

Cheap financing in China

The China A share roller coaster also saw some $2.8 trillion in value wiped off, with the sharp monthly decline rivaling the October 1987 S&P crash. The magnitude and speed of the sell-off reflect how many retail investors had been buying stocks on margin, which can lead to accentuated volatility on the up and on the down. In one quarter alone, some 35 million retail stockbroking accounts were opened in China, reflecting the mass buying frenzy and cheap financing speculation.The problem with China is that retail momentum investors have now suffered severe margin calls, which could dent investor confidence until institutional investors come back in.

Global bond jitters

Global bonds have fallen by over 6% over the past year – the worst performance in three decades! After hitting record lows, European sovereign yields experienced a sharp spike with the German ten-year Bund going from zero to 1%. The European bond jitters reverberated in our own capital markets with the SA 10-year sovereign yields selling off from 7% to 8.4% this year.

JSE reverses

The FTSE/JSE All Share Index hit fresh peaks above the 55 000 mark at the end of April but suffered a sharp reversal towards quarter-end to close slightly down for the quarter. All the above economic turmoil has also fed into weaker commodity prices, with the exception of oil, which was up by close of quarter. Resource stocks posted a third consecutive down quarter, with Financial stocks also down over 2%. Local stocks continue to be impacted by SA specific issues, such as a potential gold industry strike, an investigation into foreign exchange trading by banks and draft regulation capping rates on unsecured loans, impacting both the broad financial services industry and the furniture sector.

Naspers on a roll

Naspers remains the largest holding in our retail equity portfolios. The principal investment of Naspers is its stake in Chinese internet company Tencent. Tencent continues to make headway in China, growing new avenues in mobile offering a wide range of services which will enable them to monetize the services by means of targeted advertising. Tencent is growing its profits at over 60% per annum and this has fed through to the Naspers earnings, which grew almost 30% in the past year. While the continued volatility of the Chinese stock market has an impact on the price of Tencent, we have accounted for this in our valuation with a sufficient margin of safety.

Steinhoff offshore listing imminent

Steinhoff International, one of our largest holdings, was up close to 30% over the past year. Steinhoff acquired Pepkor to broaden its offering beyond furniture into clothing. The acquisition will place Steinhoff among the top 12 largest retailers in Europe just behind the UK’s Marks & Spencer when it lists offshore later this year. This will provide Steinhoff with a new vector for growth, with Pepkor accounting for a quarter of its profits. Steinhoff treaded water during the quarter but it is likely that there will be more excitement about the stock as the offshore listing date approaches.

Management shuffle at Old Mutual

Old Mutual plc, another large holding of ours, delivered a solid quarterly update and has placed more shares that it held in its US asset management operations during the quarter. Unexpectedly Old Mutual announced the departure of CEO Julian Roberts, who will be replaced by Bruce Hemphill, who used to head Liberty holdings.

Whereto from these highs?

Globally, markets continue to break records with the Nasdaq above its bubble peak and the Nikkei at 18-year highs. Locally, the market has shrugged off large earnings downgrades in resources shares and we have seen huge foreign flows into FINDI stocks, which have led to further multiple expansion. This is entirely disconnected from a sombre economic backdrop where S&P downgraded Eskom’s debt to junk bond status and our economic growth forecast is an uninspiring 2% for this year. Some of the growth vectors of companies, such as African expansion, appear to have become more risky at this point in time. We are also seeing a flurry of offshore acquisitions, which is more indiciative of the high rating of certain stocks and their inability to find organic growth opportunities in South Africa. At this point in time, we remain focused on avoiding stocks where the probability of capital loss is high.