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Making sense of the outlook for SA Inc stocks

As the economy continues to stutter.

The news for SA Inc has not been good. The announcement last week that South Africa’s economy had shrunk 3.2% in the first quarter of 2019 was a shock to markets. Although a drop was anticipated, the magnitude was a surprise.

Listen: Rand left reeling as GDP drops 3.2%

It also seemed like more bad news for local investors who have had to contend with a weak JSE for five years now. A large reason for that has been the depressed local economy, and the GDP numbers only added to the unease about the South African environment.

“The GDP data suggests the economy is in a much more fragile state than the market anticipated,” notes Iain Power, chief investment officer at Truffle Asset Management.

For many, this was further confirmation that conditions on the JSE are unlikely to improve. For the five years to the end of May, the FTSE/JSE All Share Index (Alsi) delivered an annualised total return of just 5.4%, and if the economy continues to stumble there may seem little reason for that to pick up.

The lesson from bonds

However, the correlation between economic performance and investment returns is not always as obvious as many might think. Perhaps the best illustration of this is that despite the state of government finances and the trouble at state-owned enterprises (SOEs), South African bonds have been an exceptionally good investment over the past five years, returning about 8.4% per annum.

“The most important thing with any asset you buy is the price you pay for that asset,” says Allan Gray’s chief investment officer Andrew Lapping. “That determines the subsequent returns.”

In the case of South African bonds, they have been cheap precisely because of the risks the country is dealing with. At times, like when Nhlanhla Nene was fired as minister of finance, they got even cheaper.

Investors therefore have to consider more than just the state of the South African environment when thinking about the future of stock market returns.

“Many people I speak to here are extremely negative about South Africa,” Lapping says. “Don’t get me wrong, there is lots to be negative about, but what does that mean for asset prices?”

In his view, the market as a whole is not particularly cheap, but this is influenced by the presence of a few large multinationals – like Naspers, Richemont, AB InBev, BHP and Anglo American – that carry little exposure to the South African economy. On the one hand, these companies have supported market returns. Without them, the Alsi would be 40% lower over the last 10 years.

On the other hand, however, they can mask the state of the broader market due to their size. If one excludes them, the remaining shares on the JSE do look somewhat cheaper, precisely because investor sentiment around South Africa is so poor.

What’s in a price?

“This is where we are looking for value,” Lapping says.

“It’s definitely not the kind of opportunity we found in 2002 or 2003 when things were extremely cheap, but we are finding selective pockets of value and over time, if the economy improves, I hope we’ll find greater value.”

This is why many local asset managers have been growing more positive about the return prospects on the JSE. They are seeing that they can buy some good local companies that have held up well even in the current economy at relatively attractive prices.

Of course, this doesn’t come without risk. As Power notes, sometimes assets can stay cheap.

“Absent significant structural reform and an overhaul of many of our SOEs, there is an increasing likelihood that South Africa is becoming a value trap as we struggle to gain any growth momentum and improvement in investor and consumer confidence,” he says. “Anecdotally, many of SA’s large corporates struggling to find growth have started to cut jobs and downsize their footprint in response to the current economic conditions.”

Investing in stocks is, however, never an exact science. It is more often about getting the odds in your favour. As Anet Ahern, CEO of PSG Asset Management notes, that means taking lessons from history.

Possibilities and probabilities

She points out that there have been five times in the past when the Alsi has delivered similarly poor returns over any five-year period. These are indicated in the graph below.

Source: iNet, PSG Asset Management

The first thing investors should take from this is that we have been in similar situations before. It is not unique.

Perhaps more importantly, however, is to consider what happened subsequent to each of these episodes.

“You have to think about possibilities and probabilities,” Ahern says. “If you were invested at these points and stayed invested, what happened in the following three years? At worst you got 16.4% per annum. At best, 40.2%.”

Source: iNet, PSG Asset Management

There is no question that the environment in South Africa is extremely uncertain at the moment. However, this is also not news to anybody. The market is fully aware of the challenges, which is why many local shares are priced the way they are.

This does, however, create an opportunity for investors. If shares are cheap, the likelihood of future returns is certainly not guaranteed, but it is greater.

“One can debate to what extent and whether the market starts getting better tomorrow or next year,” says Ahern. “But we believe there are a lot of risks discounted.”

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I notice that the JSE is on a trip to Mars for the past week or so…Maybe that’s because the country has an undeclared civil war brewing or could it be the burning of freight trucks on the N3? Nope? How about the inconvenient truth that the country’s main power supplier is flat broke and if it puts up the price of electricity any more it will shut down 90% of all industrial activity thereby causing mass UNEMPLOYMENT?
None of the above hey?
So what else can possibly explain this barometer of barking mad optimism just opposite the Bull Run?

The broader SA market is historically cheap: correct

What AG & PSG didn’t mention is that the 5 points on their charts were solid global recessions/ bear markets periods.

The difference in 2019: SA inc. in recession while the globe is in the longest bull market of the last 100 years.

Come a global bear market and non rand-hedged SA equities will likely go from cheap to filthy cheap penny stocks.

And when it goes to “filthy cheap” that is when you must buy by the bucket-load. Don’t worry, the South African economy and society is resilient. You won’t lose your money and we are not another Zimbabwe or Venezuela.

Just imagine what the market would be doing now if a business-friendly party like the DA were running things instead of the ANC, who clearly have no clue how to get this economy back on track again. South African voters seem incapable of learning a simple lesson: Governments don’t create wealth, they simply redistribute it. Without a thriving business sector, you are dead in the water.

DA is a spent force…

Maimane has chased away the traditional DA supporters.

They were the only major party to LOSE votes after the 10 disastrous Zuma years. Let that sink in…

A vote for the DA is a vote for ANC-Lite.

They lost my vote long ago, and will never get it back.

rfjock so it is true that you voted for ATM party.

Whether you agree or disagree with a party be it the ANC, ATM or DA you need to look into their manifesto. yes you get bad elements in every party BUT its not the man that is the party. Look Zuma is now gone, possibly to support the ATM party as I believe many of his supporters will go too. That might be why we have had a few resignations lately. Getting back to my point its not the man but the parties belief. I totally agree with you about Maimane but i would still vote for the party. Having said that i didn’t vote for them.

@Joe elze

Seems you are not very different to the standard SA voter.

Yes, Maimane is a poor leader for the DA but every single person should be voting based on policy and track record. Not what you heard on TV or from your friends.

The DA is about as far from ANC-lite as you can get in SA. Decent policies and a strong track record.

Saying they will never get it back makes you sound like a toddler.

PS. I don’t even vote in SA so just my neutral 2c.

I don’t think country risk (bonds) can be compared to equity risk. Without checking I can think of at least 8 top 40 counters that had large one off items or some other catastrophe in the past year. That is 20 % of the top 40 shares. Some of the good ones are leaving or are being diluted. So this is a minute market.

Looking at the history could have given some indication of the future until a few years ago. The headwinds cause by government SOE’s etc. makes the comparison similar to apples and fish. The market is nowhere near the same.

Why would one take such a huge risk on such a small handful of counters? The duel listed ones can be accessed from safer investment centers anyway.

Not for me thank you.

“One can debate to what extent and whether the market starts getting better tomorrow or next year,” says Ahern. “But we believe there are a lot of risks discounted.
Sorry, not tomorrow and not next year.
The latest on Tongaat has me wondering which large company is next to be exposed for ‘creative accounting’ and misstating financials to the detriment6 of the investor, and wondering if there are any competent audit firms in S.A.

See the Financial Times headlines: “India pushes for 5-year auditing ban for Deloitte and KPMG arm”

Seems to becoming a global disease?

The media trying to “Making sense…” in the heading.

Nothing will “make sense” when one ignores the phenomenon that SA as a country (economy) is slowly reverting back to the ‘mean average’ what resembles African countries. Long-term…sometimes too slow to notice. Sometimes good news filters in, but is merely a temporary upward blip on the long-term down-graph.
SA has been (unfairly?) developed at a higher pace than the rest of continent during colonial times, and a gold-rush helped it along mightily. SA now slowly reverting back to mean average, and manifests itself with a shrinking economy.
Also determined by changing demographics (and emigration by the minority does not help to change the picture).

(For how many years the media wrote “SA as a nation still has great potential”. If is has, the advantage would’ve shown itself long ago.)

I try to be neutral…no correct or incorrect. It’s what one accepts for yourself.
If you accept SA is great to live in (yes, it still is), then live with the excitement of potential infrastructure, and logistical disruptions and frustrations which Africa is known for. Many western consumer items will increasingly become too expensive, as SA is getting poorer. Cost of living (to have a western/modern lifestyle) will increase.
If not, then one emigrate, and go through the pain of looking forward towards a possible life prospects and new culture / future for kids, etc.
Or the middle road…remain in SA, but your money emigrates (which in itself is not great for local econ growth..)

“Past performance is not a measure for future performance”

And we’ve been in cash and bonds for four years …. thank goodness.

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