JOHANNESBURG – Higher levels of volatility, uncertainty and fear tend to provide good buying opportunities, an analyst has said.
Speaking at a PSG Asset Management road show, fund manager Shaun le Roux said one of his favourite barometers of fear in the market is his mother.
“When my mother phones me and she says ‘Shaun are you alright?’ I know the radio and the newspapers are full of doom and gloom about equity markets and the fact that they are selling off,” he said jokingly.
But a very noticeable characteristic of the market between October 2009 and August this year, has been the lack of volatility.
Le Roux said the local bourse has enjoyed a six-and-a-half year bull market and what has been extraordinary about this particular run, is that on a total return basis, the FTSE/JSE All Share Index experienced no negative rolling 12-month return between October 2009 and August this year.
Investors would have enjoyed positive returns throughout, which is unusual when considered against the long-term track record of equity markets. The average annual return during this period was over 19%.
Le Roux said the Volatility (VIX) Index (see graph below), a measure of the cost of volatility on the Chicago options market, shows volatility has been low. In the four years leading up to August this year it has been extremely low.
Source: Bloomberg; PSG Asset Management
“Volatility tends to go hand in hand with higher levels of fear and typically hand in hand with market corrections.”
Le Roux said the local equity market experienced a “mini market correction” of roughly 10% around August this year.
“I found it quite remarkable just how panicky people got in what felt like a long overdue, normal market correction and I think that is a function of the fact that we’ve had this long period of very benign markets with very strong returns.”
Le Roux said this should be worrying investors because there is inevitably going to be some degree of complacency. Investors have almost gotten used to the equity market offering returns of 19% per annum and that markets don’t correct by more than 10%.
“The last time we had a 20% correction was in 2009, which by now everyone has forgotten about. This is one of the key reasons why we are happy to sit with higher than average levels of cash in our multi-asset portfolios. We are happy to sit and wait patiently for these really good opportunities to arise,” he said.
Where are these opportunities?
While the firm has an “unashamed bias” for higher quality businesses, it is also – particularly right now – sensitive to price. It is not prepared to buy growth or quality stocks regardless of price, Le Roux said.
“It is our view that we are living in a world where people are paying up way over the odds to invest in companies that are growing faster than the rest of the market and companies where they are more comfortable with the story.”
In the global environment, economic growth has been tough to come by. Emerging markets are really struggling and incredibly low interest rates are forcing some of the money out of fixed income products into equities.
Le Roux said the parts of the equity market that have attracted these funds, have generally been those with a good story and growth characteristics. These “good story” and high growth stocks are generally expensive and they own very few of them in their own portfolios.
The JSE Industrial Index (depicted in the chart below) trades on roughly 25 times earnings, which is expensive by historic standards, he said.
Source: I-Net; PSG Asset Management
“We think this best represents the price people are prepared to pay right now for the higher quality faster growing businesses because large cap industrial stocks are probably the best examples of those.”
On a dividend yield basis, the Industrial Index yields about 2.2%, which is also expensive by historical standards.
They find above average quality businesses trading at 10 times earnings (or not much more than that) and a 5% dividend yield exciting, he said.
Le Roux said these opportunities arise because stocks that are boring, facing cyclical headwinds and not growing earnings and dividends as fast as these glory stocks are very much out of favour.
Some of the top 20 holdings in its Equity Fund include Imperial, FirstRand, Microsoft and Nampak.