There are no guarantees that the V-shaped recovery will hold

Adrian Saville

Those of us who rely on the stock market to fuel our investment portfolio returns may wish to rethink our strategies, given the poor earnings outlook for firms on both domestic and offshore stock markets. Adrian Saville, CEO and founder of Cannon Asset Managers, has warned that the constituents of the MSCI All World Index would likely see a 70% decline in earnings in 2020. He was presenting during a supplementary budget outlook webinar hosted by Liberty Group. JSE-listed firms were expected to report a 30% decline in earnings.

Joe Average into the abyss

Forget ‘Alice through the looking glass’; your journey through South Africa’s economic and financial markets is more akin to ‘Joe Average into the abyss’. According to Saville the domestic economy faces a toxic mix of macroeconomic indicators, including a 10% contraction in GDP growth; rising unemployment; and significant tax revenue shortfalls. He also offered three reasons why investors should not be overly optimistic about the apparent outperformance, where earnings are concerned, of domestic versus offshore equities. “We can identify a cocktail of three ingredients to explain this disconnect,” he said. First, rand weakness; second, the rebound in commodity prices; and third, the Naspers effect. 

The South African rand has performed poorly against the dollar, euro, and pound year-to-date. By 30 June 2020, the local currency had fallen to R17,30 to the US dollar, representing a 20% slide from the R14,30 per dollar early in the year. A weak local currency props up earnings on the JSE due to the number of firms generating revenue offshore. Commodity prices have rebounded strongly from the lows set during the early part of the pandemic-linked market fallout too, capping losses in the mining and beneficiation sectors of the economy. The third ingredient, Naspers, is to the JSE what the so-called FAANGs (Facebook, Amazon, Apple, Netflix, and Google) are to NASDAQ. These tech shares make up so much of their respective indexes that they distract the casual observer from the breadth and depth of the market rout. 

Financial market resilience

“Domestic equities have shown some resilience and there are faint signs of a silver lining; but that does not detract from the deep stress that many South African businesses are experiencing,” said Saville. He noted that the extent of the damage caused by the national lockdown would only evidence in the second half of 2020, through a growing list of insolvencies and liquidations. The question then becomes: If things are so dire, why are we seeing such a resurgence in major share indices such as the NASDAQ and S&P 500? “We could forgive these high valuations by pointing out that interest rates are near zero and that equities are priced, based not on one bad year, but on their expected performance over many years,” said Saville. 

The main reason for the disconnect between the underlying market and equities is the concerted global response to the COVID-19 pandemic. Countries around the world have coordinated their fiscal and monetary policy responses to the crisis at multiples of their intervention following the 2009 Global Financial Crisis (GFC). Mark Lovett, head of investments at Stanlib, said that financial markets saw these unprecedented policy responses as “a bridge over the crisis”. He added that central banks had not only cut interest rates “aggressively and swiftly”; but had participated in a disciplined fashion to ensure liquidity in their respective markets. “This is a central bank playbook that was partly learnt during the GFC, that has worked well in providing short-term monetary policy support through the pandemic crisis,” he said. 

Navigating tumultuous markets

What happens from here? And how should financial advisers assist their clients in navigating these difficult market conditions? Lovett observed that it would be dangerous to ignore the unprecedented financial support being thrown at global markets. “These funds are a powerful tail wind for equities despite the distressing economic environment we expect to see over the next year to 18 months,” he said. “Asset allocation is going to be extremely important and market volatility is going to remain high”. 

Saville felt it was prudent to be circumspect about market recoveries. He observed that sentiment had moved way ahead of market reality, and that the only way for recent bond market and rand strength to be sustainable would be for South Africa’s policymakers to deliver extraordinary structural change. The country is fast nearing a position where all of its domestic savings would have to be used up to fill the budget deficit. There are also plenty of risks facing local investors. 

Top among these is the likelihood of prescribed assets to address the insufficient savings to fund investments. Household budgets could be constrained too, with a likelihood of increases in capital gains tax and the possibility of another wealth tax, perhaps in the guise of a ‘COVID-19 Solidarity’ tax. But equity market performances will hinge entirely on the ability of the economy to rebound from this year’s GDP shock. Saville said that the rand was undervalued and that bonds offered value, with major caveats. As for offshore, bonds and cash were unattractive, and the dollar overvalued. 

Diversification is your free lunch

Fund managers are turning to diversification for their salvation. “The last thing you want to be doing is trying to choose the winning asset class,” said Saville. “Diversification is a free lunch, and if ever there was an environment in which you want to be diversifying, this is it”. His parting word was to remind financial advisers that investing begins with managing risk. “Make sure the asset exposure matches the risk appetite of your client, do not confuse accounting with cashflow, and place emphasis on the strength of balance sheets,” he concluded. “Hold the discipline for investing, keep your investment plan in place, and be sensitive to changed circumstances”. 

Writer’s thoughts:
Financial market uncertainty creates real challenges for financial advisers who are hard-pressed to keep their clients optimally invested across asset classes. Many financial practices rely on discretionary investment managers help in this regard, while others favour asset managers. What return do you expect from JSE-listed equities through 2020 and 2021? Or do you leave such ‘guestimates’ to the professionals? Please comment below, interact with us on Twitter at @fanews_online or email me us your thoughts editor@fanews.co.za.