Will 2021 finally be the year in which the JSE breaks out of its prolonged period of underperformance?
What are the global factors at play that might influence returns on the local market?
We asked seven local asset managers about how they are positioning their portfolios going into the new year, and what they see as the likely range of outcomes on the JSE.
Rory Kutisker-Jacobson, portfolio manager at Allan Gray
We are finding much greater value than we have for some time on the JSE, but risk means that more things can happen than will happen. And if we’ve learnt anything from 2020, it’s that we have absolutely no idea what 2021 holds.
Given the heightened level of uncertainty prevailing, and that nobody knows for sure when or how the world will emerge from the Covid-19 crisis, we have positioned our portfolios for a wide variety of outcomes, rather than taking a big bet on one particular scenario prevailing.
An example of this is how we have positioned the domestic equity portion of our flagship funds. If we place our equity positions into broad buckets, you will see a couple of competing themes emerging:
In the first broad bucket, we are invested in a number of shares that will continue to perform well irrespective of the prevailing economic environment in South Africa and how long it takes the world economy to recover from the pandemic. Examples here include Naspers and British American Tobacco.
We are invested in a number of commodity shares in the second bucket. These are trading on attractive valuations and will do disproportionately well in a scenario where the rand weakens for domestic-focused reasons or inflation spikes globally. The largest exposure here is to Glencore.
The final bucket includes shares that are cyclically depressed, and domestic-focused businesses whose fortunes are more directly tied to the South African economy.
The current environment is very challenging for these businesses, and many of their valuations have been punished. However, valuations could re-rate materially if sentiment improves, or if the economic environment recovers faster than expected.
So, while the risks are arguably higher for these businesses, the upside is too, and many of the negative expectations are already more than priced in. Volumes and profitability do not need to recover to pre-Covid-19 levels for these to be attractive investments. The domestic banks, such as Standard Bank, fall into this category.
The common thread across these buckets is that we are finding compelling value trading at a significant discount to our estimate of fair value. As a result, overall, we are cautiously optimistic on the returns available in our funds today.
Abdul Davids, portfolio manager at Kagiso Asset Management
The domestic equity market has recovered strongly from the March lows and, notwithstanding significant new waves of coronavirus infections in many parts of the western world, the news of two credible vaccines have buoyed the JSE, along with most global equity markets.
Record low interest rates coupled with announcements around substantial economic stimulus packages in most advanced economies, provide a favourable environment for risk assets like emerging market equities, which should continue to prosper in 2021.
China’s aggressive stimulus program has benefitted commodity markets and the JSE’s mining sector should deliver near-record profits in 2021, despite recent currency strengthening.
This is expected to provide a strong valuation underpin for the mining sector and overall market.
Small and medium-sized JSE-listed companies have lagged in the recent recovery and it is our view that a select few among these are poised to deliver reasonable earnings and cash flow growth in 2021. The above sectors are therefore likely to contribute to continued gains in the JSE.
However, we would caution against excessive exuberance as a rapid deterioration in the global economic backdrop could severely dampen risk appetite and the South African economy remains fragile and under significant strain. We believe there will be casualties among local companies with weaker balance sheets and business models.
In addition, we are likely to see a delayed impact of the 2020 economic contraction on employment numbers and consumer indebtedness. These are significant headwinds to earnings for consumer-focused domestic companies and sectors on the JSE.
Piet Viljoen, portfolio manager at Counterpoint Asset Management
What does 2021 hold for investors? As usual, I have no idea.
At any specific point in time, any number of possible economic and political futures lie ahead. And even if we knew exactly what was in store, it’s hard to then judge how the market will respond to events.
And that is the job of a portfolio – to give investors exposure to different possible futures, as a priori, we have no idea of which one will eventuate.
A portfolio holds different assets to take account of the inherent uncertainty embedded in markets.
Today, there is a view in markets that we are headed for a reflationary period. Such a period would favour emerging markets, hard assets and asset-intensive businesses. South African equities will do well in such an environment.
Our equities are cheap and bond yields are high. Foreigners are recognising this, and have started to buy our assets.
In such an environment, the rand will also do well. Its fair value is probably around 14 to the dollar, and it could easily get there. The US dollar is the most overvalued currency in the world.
On the other hand, there exists tremendous excess capacity globally, and in the short term we could very well experience a deflationary scare in the next year. If that happens, the dollar will do well and all the previously mentioned assets will do poorly. So, some rand hedge assets could also make sense.
Reflation is a higher probability event, but deflation should not be ignored when constructing one’s portfolio.
Saul Miller, portfolio manager at Truffle Asset Management
Globally, most markets are trading above their historic multiples, but interest rates are also at low levels. Historically this has been associated with poor long-term prospective returns from both bonds and equity.
However, in the short-term markets will likely be buoyed by continued positive economic news flow, a potentially successful vaccine and US fiscal stimulus resolution. The concern is that an economic recovery results in an up-tick in inflation, which gives rise to an expectation of interest rate hikes.
We are uncertain of the timing and extent of these moves. We think some precaution in terms of portfolio construction is warranted, especially given our concerns regarding the expectation of paltry long-term returns.
Although valuations globally and on average are expensive, pockets of value remain.
While most equities would underperform in a sell off, equities trading on reasonable valuations should ultimately provide decent returns to the long-term investor.
Commodities should perform well in an environment of rising inflation and weaker currencies, especially those where there is limited supply growth. However, we need to be vigilant where certain commodities have run well ahead of long-term fundamentals.
The value versus growth debate has been hotly debated this year, with some arguing for value stocks to finally outperform growth as economies recover and growth becomes less scarce. On the other hand, such a rotation may be short lived as many value sectors like financials are in structural decline compared to growth sectors like tech.
Given the uncertain outcome, we think some exposure to both is warranted. This can be partly achieved by investing in emerging markets. Tencent (Naspers’s major asset) is an example of a growth share which is not as expensive as some of the US listed tech companies.
Many South Africa-exposed shares were hammered in the Covid outbreak. Although many have since recovered a significant portion of their losses, there are still opportunities offering value.
There are some property companies for example, with decent assets that should be able to manage their way out of high levels of indebtedness. Suspension of dividends, or sales of some of their properties at prices remotely in the range of their balance sheet valuations will help allay investor concerns regarding their over-levered balance sheets.
Andrew Dittberner, chief investment officer at Old Mutual Wealth Private Client Securities
Given South Africa’s tenuous situation from a fiscal perspective, very little in the way of economic tailwinds are going to assist the market in the near future. Investors therefore need to be very selective from a stock perspective, while avoiding the landmines of tomorrow, of which there are likely many on the JSE.
Maintaining a disciplined investment approach of avoiding companies that are overly indebted, lacking cash flow, or have a history of poor capital allocation will stand you in good stead over the long-term, while also reducing the probability of capital losses in the shorter-term.
Against the above backdrop, we are avoiding the listed property space.
Many listed property businesses are bumping their heads against their debt covenants while sitting on bloated valuations for their underlying properties, which have not been maintained adequately over a long period of time. Compounding the situation is the shift to online in the face of economic lockdowns.
Other areas of concern are those sectors that are more heavily reliant on a resilient economy and consumer. Examples would include SA facing industrials, the soft retailers and even the banks and life insurers to a certain extent.
Importantly though, one also needs to be cognisant of valuations, acknowledging that the poor outlook may already be in the price.
Any good news, be it in the form of a global economic recovery or headway having been made on the reform front, could potentially find its way into share prices very quickly.
One must also remember that there remain some exceptionally well managed businesses on the JSE that will navigate the current environment despite the economy. These include the likes of Spar, Shoprite, AVI, Mondi, Bidcorp and Quilter.
Diversified miners are also well positioned to benefit from a recovering global economy and resilient Chinese demand. With improved balance sheets, undemanding valuations and generating free cash flow at current commodity prices, this is an area of the market we remain exposed to going into 2021.
Herman van Papendorp, head of investment research and asset allocation at Momentum Investments
Although the balance of probabilities is in favour of a positive vaccine outcome and hence a conducive environment for riskier asset classes like equities in 2021, we acknowledge that there could be sporadic downside risks for these assets during the year in case of disappointments on the vaccine implementation front.
Riskier asset classes should benefit from a split US Congress and more geopolitical predictability. The former should imply a lower likelihood for increased regulation and taxes, while the latter should intimate less volatility in markets.
In general, an improved global growth picture, together with still ultra-easy policy settings, should reward less risk-averse investment behaviour in 2021.
In such a risk-on environment, investors should be positioned for a weaker US dollar, a drift higher in US bond yields, expect general support for more risky asset classes such as equities and credit and be prepared for some equity style rotation from growth to value and regionally should favour non-US equity markets (including emerging markets) over the more defensive US equity market.
In contrast, safe-haven asset classes like global bonds, cash and gold are likely to face headwinds in a cyclical recovery phase, with bonds facing the additional challenge of somewhat higher inflation.
Valuations look expensive in most global asset classes, with low yields implying lower-than-historic forward returns across-the-board if there is some reversion towards longer-term valuation means.
It looks like the stars are finally aligning for the South African equity market, with a strong expected profit recovery in 2021 providing fundamental support on top of an envisaged conducive global risk-on environment. A more favourable valuation underpin after years of poor performance should enhance potential return upside.
Kyle Hulett, head of asset allocation at Sygnia Asset Management
The past year can now be viewed in hindsight, and 2021 looks set to redeem some of the pains of 2020. The only concern is the widespread consensus that 2021 is going to be a good year. This does not necessarily mean that the consensus is wrong, and we concur there is a lot more upside in markets, driven by global factors.
South Africa will rise with the tide, maybe higher if the government secures wage freezes, drives infrastructure investment, and improves confidence; and maybe lower if government continues its current path.
Looking ahead to 2021, there are some known knowns:
The last decade has been filled with event risks including the Great Financial Crisis, Grexit, Chinese shadow debt defaults, US/China trade wars, Brexit and most recently Covid-19. The world has muddled through the various events by lowering interest rates and using creative monetary policy. Covid-19 changed that, along with the largest fiscal support in two decades.
Next year will see the impacts of the fiscal spend, alongside a continuation of $4 trillion in quantitative easing, as the global economy recovers strongly on the back of vaccine rollouts. At the same time global trade is likely to rise due to a more collaborative US foreign policy and falling trade costs because of low oil prices and low US interest rates.
All of this makes a fantastic mix for emerging markets.
There are however, some known unknowns to consider.
Two of the remaining known risks include the US Georgia senate race and Brexit. The former, if the Democrats win both seats, could lead to a stronger US but also higher US interest rates, which would be bad for the rest of the world. It may also see increased regulation and taxes, which would be bad for US equities. Fortunately, this risk is low.
Brexit is an unknown. The very nature of posturing required to come to a compromise could result in excess market volatility and uncertainty. However, after three years of Brexit noise, markets are pricing in a lot of downside and moving on. The most likely outcome is further delays, and this will not disrupt markets meaningfully.
Finally, we have to consider the unknown unknowns.
The big question going forward is the unknown risks or the black swans, such as Covid-19, that strike out of the blue. Unfortunately, we have survived the last decade by taking on more and more debt with global debt-to-GDP ratios at record highs. This high level of gearing or leverage intensifies any risk events that may occur and reinforces the current secular stagnation or low growth environment.
While the strong fiscal and monetary support and earnings rebound over 2021 should help the world push through any small event risks, we could end up paying the price beyond 2021 for simply kicking the can down the road.
Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.