Not so fast with your Champagne celebrations
If the financial presentations shared with an audience of financial and investment advisers during the 2022 Virtual Meet The Managers event are anything to go by, then local investors might start readying their best Champagne for some end-of-year return celebrations. The handful of talks we attended during the event, hosted annually by The Collaborative Exchange, suggest that those with an appetite for carefully-selected local equities are in for a very good year.
The Russia / Ukraine war sullies the outlook
Iain Power, Chief Investment Officer at Truffle Asset Management, offered up three factors to support his pro-equity narrative, though he warned that this year’s outperformance would not come from over-priced growth shares. Factors of interest included the end of pandemic, the speed of post-pandemic market recoveries and the overheated nature of US financial markets. We will elaborate on each of these before sharing the asset manager’s thoughts on South Africa Inc, which included rather positive assessments of a number of local equities. Our only concern with his mostly-upbeat sentiment was that the still-unfolding Russia / Ukraine conflict was not adequately priced in, locally or abroad. Time will tell, but we think you should keep that Champagne in cold storage for now.
The first factor is that the Covid-19 is firmly on the back foot. “We think we are at the beginning of the end of this pandemic,” said Power, while screensharing charts showing declining deaths and hospitalisation rates despite the more infectious Omicron variant. “Compared to previous waves, we are not experiencing as much adversity in terms of complexity of cases and mortality despite the very sharp spike in viral counts and viral infections; and this [scenario is playing out] around the world”. The hope is that the final easing of in-country restrictions on social gatherings will result in a sharp rebound in the services element within economies, including entertainment, restaurants and travel. This should be good news for emerging market economies where tourism and travel often make up a big percentage of total GDP.
The Western world is awash in easy money
Factor two is that financial markets have recovered way faster following pandemic than the 2008/9 Global Financial Crisis (GFC). In fact, the speed of the post-pandemic recovery is one of the starkest differences between the GFC and the 2020/21 pandemic crisis. “We have seen a sharp recovery predicated on the unprecedented amount of monetary and fiscal stimulus that was injected into economies by global central banks,” said Power. He observed that developed market central banks chipped in four times more in fiscal stimulus during pandemic than during the GFC, with most of this cash going directly to businesses and consumers as opposed to bailouts of banks and insurers. This sea of money propelled economies and asset prices to levels well in excess of where they were pre-Covid, but not without consequences, aka inflation!
The third factor influencing the investment landscape is that the United States (US) equity markets are overheated. This as the US and other developed market economies struggle with the consequences of the loose fiscal and monetary policy practised through pandemic. According to Power, the US economy is running “very hot” as evidenced by a manufacturing sector that is operating close to capacity and excess wage growth in a tight employment market. US wage growth is at close to 5% with more than 4.6 million job openings that are proving hard to fill. If only South Africa faced similar problems!
The US Federal Reserve came in for some criticism for sitting on its hands insofar tackling the resulting inflationary pressures. “You would think, having seen all of these factors, that the US Fed and other central banks would be well on track in terms of pushing up rates to ensure that inflation does not lift and get out of control in terms of secondary downstream effects; but that is not the case,” said Power. “There is a definite risk that rates are going to go up more than expected [and] advisers should be thinking about this risk in the way they position portfolios”. The looming threat of inflation and rate hikes is juxtaposed with record profits from US companies, with investors prepared to invest at peak price-to-earnings multiples in return for last year’s peak earnings.
As silly as a dog chasing its tail…
Truffle Asset Management warned that chasing higher US equity prices was “a recipe for losing capital over the long term [given questions overs] the sustainability of earnings and returns in light of some of the cost pressures, which are starting to move through the system”. They preferred avoiding the US equity market, and especially some of the expensively-priced growth companies, due to the risk of big price corrections when interest rates finally take off.
Investors who are not keen to overload their portfolios with these ‘smouldering’ offshore growth shares are turning to local opportunities. Power was critical of South Africa’s economic growth prospects; but indicated that many locally-listed firms were cheap relative to their international peers. He separated the best value propositions in SA and offshore equity markets into four buckets, which we expand on in the following paragraphs.
- Bucket one, businesses that are poised to gain significant market share. “We are focusing on businesses that have the ability to win market share that will manifest in them outperforming over time,” said Power. It is anticipated that these firms will deliver double digit returns over the coming 12-24 months. Shares that fit this profile include Investec, which currently trades at a big discount to its book value; Remgro, which has been going through corporate restructuring and offers a significant discount to its net asset value; and Momentum, which trades on a 7% forward dividend yield.
- Bucket two, companies that have yet to return to their pre-pandemic earnings levels. There are a number of companies that show promise, but have lagged slightly as they emerge from the coronavirus mess. These include hospital groups Mediclinic and Netcare and one of the biggest food service businesses outside of the US, Bidcorp Group. “We think as travel gets back to normal, and people want to go out to restaurants and start to normalise their social behaviour, you are going to see a business like Bidcorp benefit from that activity,” said Power.
- Bucket three, cheap companies. The third bucket, also called the value bucket, contains shares that are really cheap with reasonable balance sheets and excellent prospects for earnings recoveries through 2022 and 2023. The likes of Absa, Astral Foods, British American Tobacco and Telkom all got a mention.
- Bucket four, was for resources shares. “There are some decent resources businesses which are still trading on pretty attractive free cash flow yields, where the fundamentals in terms of demand and supply are still pretty positive,” said Power, who suggested loading up on the likes of Sasol to take advantage of the looming global energy crisis; Impala Platinum for its ability to supply platinum group metals into a constrained market; and Glencore, which is a timeless play on so-called green metals as the world transitions away from fossil fuels.
This article does not constitute financial advice
This writer will remind his readers that this article does not constitute financial advice… You should consult with your financial adviser and / or asset manager before committing your hard-earned savings to any of the aforementioned investment opportunities. As for Power, he said that asset managers who trusted in consistency and “focused on what they did best” would continue to generate consistent returns over the long-term. And that, dear reader, is what you need to do to ensure that your portfolio outperforms over five, 10 or 20 years.
Writer’s thoughts:
The ebb and flow of the offshore vs onshore investment debate was brought into focus in a recent LinkedIn post that gave an update of the five-year ‘wager’ between ‘offshore everything’ Magnus Heystek and South Africa ‘bull’ Piet Viljoen, with Viljoen’s ‘local is lekker’ selection off to a flying start… It seems South Africa Inc has the edge for now… Do you think this will be the case in five, 10 or 20 years? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.
