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Finally, local equity is lekker again

14 October 2021 Gareth Stokes

Equities that fall into the South Africa Inc basket have made a staggering recovery since the bottom of the pandemic crisis, with banks, retailers and resource shares gaining favour over the likes technology favourites. “Owning South Africa Inc and resources was the place to be since the pandemic lows, which meant that local became lekker again,” said Rehana Khan, portfolio manager for Ninety One Equity Fund. She was commenting during the fund’s recent domestic and global equity outlook presentation.

The pandemic inflection point

There is a clear segmentation between pre- and post-pandemic returns generated by JSE-listed companies. Khan explained that in the five years leading up to Covid-19, investors had doubled their capital by staying invested in Naspers, while the index return was mediocre. Over the same period, SA banks were mostly static, while SA general retailers were going backwards. This general malaise in the so-called SA Inc segment of the market was due repeated country GDP and company earnings downgrades. The good news is that the best investment opportunities occur when market sentiment is at its worst. 

By the middle of 2020, pandemic fatigue had reached its peak. “We saw aggressive downgrades to earnings forecasts for SA Inc shares; and this is when we started to find gems and opportunities,” said Khan. Around that time, the discussions that the fund’s portfolio managers were having with banks and retailers suggested that the coming earnings were not going to be as bad as expected. Consumers were on a stronger footing than initially feared thanks to the 300 basis point cut in interest rates; the special grants offered by government in response to Covid-19; assistance from the financial services sector through depth repayment and premium relief; and, sadly, billions in insurance pay-outs. 

Evidence of this consumer support were seen in January earnings updates from the likes of Foschini and Truworths, and more recently in stellar results from the large banks. The result: between 31 March 2020 and 31 July 2021, SA Inc shares contributed more than a third of the JSE All Share’s 60% gains, with general retailers up more than 100%. 

Get the timing right; or suffer the consequences

The trick, from an asset manager’s perspective, is to time the switch from one segment of the market into another. Getting the timing right delivers significant return to the portfolio; getting it wrong, causes all kinds of problems. “We know what to do when the earnings have been revised upwards at a reasonable valuation, we own those companies; but we spend a lot of time deciding on the buy and the sell windows,” said Khan, explaining that it was not as simple as charging into a share at the first sign of its earnings forecasts being revised higher. “Our analyst team [directs a lot of effort into] understanding what is embedded in consensus forecasts and comparing these to what our forecasts are and understanding where that Delta lies,” she said. Other considerations include ESG factors; the nature and sustainability of a firm’s earnings; and commodity price and market cycles. 

The calm approach by asset managers contrasts with that of local investors, who were panic struck during the pandemic correction and remain concerned about potential equity returns today. “South Africans like to worry. We worry about equity markets when they are low; but we also worry about equity markets when they are too high,” said Hannes van den Berg, portfolio manager for Ninety One Equity Fund, before listing a handful of local and global developments that equity investors need to keep a close eye on. Global issues include Evergrande and China’s regulatory environment; the normalisation of policy at central banks; and the debt ceiling in the United States. Locally, we face lacklustre economic growth; policy uncertainty; and the huge hit to business confidence caused by the July 2021 civil commotion in Gauteng and KwaZulu-Natal. And, of course, we still have the pandemic to contend with. 

Climbing the wall of worry

Against this backdrop one would expect equity returns to be dire… Instead, investors have benefitted from rapid and sustained equity market moves. “Equity markets have managed to climb the wall of worry, globally, as well as in South Africa,” said Van den Berg. He added that the best way for asset managers to cut through the noise, and follow through on their investment philosophies and strategies, is to get a clear picture of the market cycle. “Our London colleagues believe we are reaching the point of peak growth; a point at which central banks will start to reduce liquidity, with the chance that interest rate hikes will follow,” he said. 

Following the March 2020 collapse, markets entered a repair phase with plenty of monetary policy and fiscal assistance from central banks and governance. Ninety One believes that markets are now exiting this repair phase to embark upon the recovery or expansion phase of the cycle. There are risks of another downturn or recession; but it is too soon to speculate on when such event might occur, due to much of the world being pencilled in at above trend GDP growth for 2021 and 2022. The question becomes how to convert all of the above information into an SA equity strategy. 

A move back into banks and retailers

Khan explained that going into pandemic, the fund had had a reduced allocation to banks and SA retailers. Around August last year, they identified a gap between their earnings forecasts compared to consensus forecasts for these sectors, and started building up positions in selected shares in these sectors, including the likes of Absa and Pepkor. Much of this transition was funded by reducing exposure to British American Tobacco and Naspers. “Our focus on earnings revisions at a reasonable valuation is a unique philosophy,” concluded Van den Berg. 

“Environmental, social and governance factors are also being thoroughly integrated into the way we think, from both the top down and the bottom up perspective”. He added that the fund manager took impact investing and investing for a world of change seriously, and that these factors were top of mind in the analysis of opportunities and the asset manager’s ongoing engagement with companies. 

Writer’s thoughts:
It was refreshing to attend and equity presentation where the offshore versus onshore debate was set aside in favour of a frank assessment of local equity opportunities. It would appear that SA Inc, or shares exposed to the local business environment, are in for a good year or two; but the threat of the next market correction always looms. Are you comfortable taking a bigger slice of SA Inc in your clients’ portfolios? Or do you leave the tough asset allocation decisions to your preferred active asset managers? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected]

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