The AI and gold thread you can weave into client narratives
AI, geopolitics and persistent inflation are among the theme’s asset managers are tracking as they position investors for optimal returns in an uncertain world. Getting to grips with these macroeconomic drivers helps inform views about bond yields, equity market valuations, geographic exposure and gold’s resurgence.
Is the S&P in bubble territory?
In the latest instalment of The Times with Allan Gray, a panel of equity and fixed income portfolio managers explored these themes while addressing questions raised by advisers and clients over the year. After a brief reflection on how the Allan Gray and Orbis fixed income teams viewed bond exposures, the panel dived into equity valuations in a world blighted by conflict and trade tariffs. Tim Acker, a portfolio manager at Allan Gray, said many advisers had expressed concern over the S&P 500 being in bubble territory.
Equity analyst and portfolio manager Varshan Maharaj said it was difficult to answer whether an index was cheap or expensive because of the broad level of dispersion between (and within) markets. “The United States does look expensive relative to history measured by its price-earning (PE), price-to-sales or Shiller ratios,” he said. By contrast, small frontier markets carry valuations in the eight to 12 PE range. For context, the free float market cap of frontier markets is USD300 billion, a tenth the value of Bitcoin and one-hundredth of gold.
Advisers and investors have plenty of questions about the risks keeping portfolio managers awake at night. Mark Dunley-Owen, a Bermuda-based portfolio manager for Orbis, singled out artificial intelligence (AI) as a game changer, saying the principal concern is over what the end state of AI looks like. Asset managers are wrestling with the transformational impact of the technology and its progression. “There are a number of companies where valuations are being driven by AI, either because they link to AI or because they are potential laggards,” he said.
The end-state of the AI revolution
Examples include US construction stocks whose order books, margins and revenues are on the rise due to demand for data centres, and utilities firms exposed to AI’s insatiable appetite for electricity. Dunley-Owen explained that if AI turns out to be a very high return end-state, then these types of companies are underpriced despite their higher-than-trend valuations. But if AI travels a more volatile path to its end-state, these companies are best avoided in favour of stocks that are currently perceived as laggards.
The discussion turned to how the so-called Magnificent Seven stocks would fare in the coming years based on their direct or indirect exposures to AI; how the adoption of this technology was affecting their revenue models; and the consequences of these firms having to divert cash flows to capital expenditure. The portfolio manager argued that Nvidia was in the sweet spot of the trend, while the likes of Meta and Google may find their revenue models challenged by large language models. What happens, he asked, when search shifts to ChatGPT or similar?
Acker asked panellists the perennial South African asset allocation question about the right level of exposure onshore versus offshore. “SA is such a small portion of the world, and we have a massive opportunity set offshore; my default is to be at the max offshore weighting allowed under the regulatory guidelines,” Maharaj said. He added that portfolio managers will allocate slightly more domestically when the rand is weak or when the SA Inc stocks are cheap.
Equity returns could be lower
Allan Gray fixed interest portfolio manager Thalia Petousis warned against investing one’s entire offshore allocation in the tech-heavy NASDAQ, while Dunley-Owen cautioned advisers and investors against expecting a continuation of the returns they had seen over the past three years. “The absolute numbers are too high,” he said. “This does not mean the market is going to crash, but returns could be lower … history would suggest that from here, valuations are going to be lower, and equity markets either go sideways, or have a dip and then a recovery.”
Acker wanted to know more about the prospects for gold given the precious metal’s impressive run from around USD2400 an ounce in January to north of USD4000 in October. It turns out the commodity’s resurgence has little to do with retail buyers chasing exchange-traded funds and Krugerrands. “The central banks, as a group, have been among the biggest buyers of gold in recent years,” Petousis said. She commented on recent World Gold Council surveys showing an increasing appetite for gold to bolster country reserves, especially among emerging market central banks, and most notably China.
Countries are favouring gold alongside dollars and euros in response to a range of structural risks. One fear is that they suffer a similar fate to Russia, which has seen severe financial sanctions including being “locked out of SWIFT” following its invasion of Ukraine. The fixed interest expert described how Russia had been quite tactical about sanction-proofing its reserves, selling out of US Treasuries and increasing central bank gold holdings as early as 2014, when they annexed Crimea. High US inflation and weak returns from US Treasuries since 2022 are further motivators for central banks to own physical gold.
How the funds rate gold at USD4000
But what about gold exposure in Allan Gray and Orbis funds, Acker mused. “We have owned gold,” said Dunley-Owen. “Bonds have been less attractive than other assets for the last five years, and if we do not own bonds, we have got to own something else.”
Physical gold has run faster and further than anticipated, but mining stocks have been slow to respond. “Historically, if the gold price went up one times, gold miners would go up more than that,” he said, adding that Orbis has had some exposure to gold mining shares for years with poor results. The fund is still invested in two mining companies, though these make up a very small slice of the portfolio.
Maharaj commented on the extreme weighting of mining shares on the JSE at present, with gold counters making up 16% of the All Share Index (ALSI), rising to 23% if you include the platinum group metals (PGM) counters. “Given the volatility and the fact that they do not pay out a lot of the free cash flow, I would think that is too much exposure to have in those sorts of shares,” he said.
Debt and fiscal deficits weigh on bonds
The panel noted that global fixed income held little appeal at present, with most developed economies facing high debt-to-GDP ratios, large fiscal deficits and inflation eroding real returns. Defaults among major issuers are unlikely, but investors risk being repaid in devalued currency, effectively cancelling out some of their yield. According to Dunley-Owen, currency volatility further complicates bond allocation decisions. Orbis remains defensively positioned, holding below-index exposure to bonds and favouring gold and select equities.
Turning to SA equities, the panel said the ALSI was above its long-term dollar resistance level. Maharaj said there were still opportunities among the banks, where dividend yields exceed PE ratios, and in diversified miners such as Exxaro and African Rainbow Minerals, which trade at lower valuations than some global peers. And finally, the defensives such as Anheuser-Busch and British American Tobacco trade on attractive multiples with reliable dividends and some protection against inflation.
Navigating your clients through AI, geopolitics and inflation
The panel’s message was one of cautious pragmatism. They said financial market narratives were being shaped by a handful of powerful forces, from AI and geopolitics to fiscal pressures and inflation. Dunley-Owen concluded that every asset class seemed priced for optimism, calling for careful weighing up of asset class and geographic exposure within portfolios. Against this backdrop, the panellists described a broadly defensive stance, highlighting select opportunities in frontier markets, equities, gold and South African stocks trading at attractive valuations.
Writer’s thoughts:
The Allan Gray and Orbis portfolio managers describe financial markets weighed by high valuations and stubborn inflation. How are you helping clients to stay invested without taking on unnecessary risk? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.
