RYK VAN NIEKERK: Welcome to this Market Commentator podcast, it’s my weekly podcast where I speak to leading investment professionals. My guest this week is Hlelo Giyose, he is the chief investment officer of First Avenue Investments. Hlelo, welcome to the Moneyweb studio, earlier I looked at a graph of the SWIX, of course the Shareholder Weighted All-Share Index, which is the benchmark for many unit trusts and collective investment schemes in South Africa. Year-to-date it is down 13.5% and over the past 12 months, around 11%. A dreadful performance and that is in nominal terms, excluding inflation, what is your sense of this performance and where we are going?
HLELO GIYOSE: If you open it up a little bit more I think there’s a disconnect in fortunes between different sectors in there. I think year-to-date, if you were to look at it, the resource sector is up in absolute terms – I forget what the number is – but it’s in double digits and financials and industrials is down 13% or so. So when you look at where the SWIX is today it’s purely because the financials and industrial sectors have been very depressed and the reason why is because those are the sectors that have caught most of the angst related to both what’s been going on in South Africa in the past few years but also emerging markets. Take, for instance, Anheuser-Busch, which is not in the SWIX I know, but it has suffered from its exposure to emerging markets both in South Africa and Brazil. But commodities and resources because they supply into the global growth environment or the global growth narrative that’s driven for the most part by the United States and, of course, supported by China, that’s fared a lot better. There’s a disconnect though, China has been really terrible this year and I’m not really certain why your biggest customer, China, goes into the doldrums and mining companies here haven’t been in the doldrums but we think that’s coming.
RYK VAN NIEKERK: But this is not only a South African story, we are seeing a lot of pressure around the world, China is down around 24% year-to-date and the US has also seen a correction, where do you think we are in the investment cycle?
HLELO GIYOSE: This is a really late cycle, it’s late, late, late cycle here. China is already experiencing convulsions, not just from the trade war but from its own growth model, which is debt-fueled. Someone used a term the other day that China has a debt iceberg, so what you see on top is obviously government debt, which has really good credit but below that there are guarantees to state-owned enterprises worth US$7 trillion and that debt is a lot bigger than the creditworthiness of state-owned enterprises on their own. So they have a bunch of Eskom’s and SAA’s going on over there and some of those SOEs, most of them in a way, have issued bonds and those bonds, their credit defaults swaps have gone through the roof, meaning that the insurance necessary to protect yourself in case of default, that price has shot up. So no wonder the government of China is really trying to show confidence through talking, above all, but promising to also bail out companies, both private, by the way, and state-owned, to try to help the economy and to help enterprise over in China.
RYK VAN NIEKERK: Is it working?
HLELO GIYOSE: Well, not yet, no, it’s not working yet. It will take a little while to work, some of the measures they’ve announced will take a while to work. If you tell someone I’ll give you a tax cut or I’ll get a tax cut at the end of the year or in 12 months but I need to be alive to get that tax cut, I may have losses up until then. If you tell companies, for instance, foreign companies in China, not to leave but to invest capex in China, not to leave because of trade wars but to invest capex in China, they think about it and say, well, my capex cycle is coming up not this year but next year and if this trade war is protracted do I really want to be in China or do I want to be in Vietnam. So we don’t know if it’s working yet, it hasn’t had enough time to work. What we do know is the trouble that is actually brewing in the economy now is terrible, terrible trouble. The economy we know is growing at 6.5%, which is down from 6.7% but the real economy, the real pace at which the economy is growing in China is a lot slower and I think we are all going to be shocked and surprised at how much more the economy would have slowed down when they put out the next number.
Donald Trump has spiked the punch bowl
RYK VAN NIEKERK: But we are seeing some of the best correlated economic growth in many decades. The US will probably grow at its fastest pace this year, but you seem to be quite negative, thinking that this growth can stall and stall quite quickly.
HLELO GIYOSE: A couple of things have happened here: I think that not many folks realise how much Donald Trump spiked the punch bowl when he got into office and true to his ego he wants to be remembered as the best American president ever or the best president in America’s history and so he’s not going to have a bull market, an economic expansion crumble on him. He wants to extend it by as many times and as far out as he can. If he can be president for eight years, meaning two terms, and have the economy growing in each one of those years he will do it. So when he got in the first thing he did was he deregulated industry, he gave industry a few more legs or a few more pillars from which they could generate additional revenue, additional growth, by not having to contend with regulatory measures. People like Jamie Dimon, the guy from JPMorgan, say that one of the reasons why their results are so good is because of what he did in deregulating part of the financial services industry. The next thing he did in order to extend growth because the cycle could have ended but to extend growth he cut taxes, he cut taxes for corporates and for the wealthy. So that extended the economic expansion in the US, which by definition also expanded earnings growth. Now this year is the second year, he’s been in office for two years, and during the mid-terms he was talking about a tax cut, not for the middle income, without having accepted that the tax cut before was for the rich but not for the middle income, and he wanted to use that to encourage middle-income people who may potentially vote Democrat to stay Republican. If he did that then he would again have the House, have the Senate and the White House to be in sync as Republican and pass another law to extend economic growth. Well, that plan has stopped dead in its tracks because the House is with Democrats and they are not passing any more stimulatory packages and policies that Trump is proposing. So what that tells you is we have had good growth in the system, which he created by extending economic expansion, we’ve also had inflation from that and from trade tariffs. He’s loading up again in trade tariffs from 10% to 25% on January 1 and yet we don’t see where the next growth trajectory is coming from policy-wise. We also know monetary policy interest rates aren’t going down, so where is growth coming from from here onwards, where is it coming from? We might be looking at peak earnings today and we might be looking at further rising inflation and slowing GDP growth.
RYK VAN NIEKERK: But you have unemployment in the US at all-time lows, there is a big consumer drive in the US that may support the current economic growth. Do you think we will see as many economists predict a recession by 2020 in the US, do you think that is a possibility?
HLELO GIYOSE: I think it’s a real possibility. By the way, economic growth is year-on-year, so if you’re talking about unemployment at record lows this year, if you want to grow the economy, therefore, next year, unemployment has to go from 3.7% to 3.5% to 3.3% to 3.2% and that’s what grows an economy, alongside wages, which brings inflation, which brings interest rates. It doesn’t help that Trump is hell-bent on subjugating China to becoming number two and they have to agree to it, to become a number two country, through tariffs. America is not disadvantaged one bit. As you pointed out, great employment numbers, great wealth creation on the stock market, great industry, it’s not poor but he just wants China to agree to be number two, not number one. Until China signs that agreement, as Japan did in 1990, by the way, until China signs that agreement we are going to have a 25% tariff. So if you have a 25% tariff, tell me where is growth coming from? Where is 3.3%, or 3.5% unemployment, a drop in unemployment, where is that going to come from if you don’t have another stimulus measure like tax cuts, so where is growth coming from? A lot of the benefits, by the way, of the tax cuts that he put in place have gone into share buy-backs. So we have great profitability in the United States today, which is what makes it difficult to believe there will be a recession but if I’m going to grow on the great profits I have this year to next year, how will that happen?
First Avenue will always be conservative
RYK VAN NIEKERK: Let’s talk about markets, how do you invest in such a market?
HLELO GIYOSE: First Avenue’s posture will always be to be conservative and conservative does not mean that you run with 15%, 20% cash, we’ll never propose that. Our proposition is very simple, at all times seek companies that have as stable growth as possible, if not in absolute terms, at least relative to other companies. The reason why you have to have as stable growth as possible is that when volatility hits, depending on when you invested, when volatility hits and share prices exhibit volatility, share prices do not go below your in-price. That is a point and if they go below your in-price on companies that you’ve invested in, you may not get that money back. So always protect your capital.
RYK VAN NIEKERK: But your biggest shareholding or your top investment in both your Sanlam collective investment-focused fund, as well as your collective investment equity fund is Naspers, over 20%
HLELO GIYOSE: So the way to look at that is to take Naspers and add to our Naspers other cyclical sectors like resources and then add to that, it’s very small obviously, construction companies, and then add to that, even smaller, property companies, and add to that, even smaller, furniture companies. What is our exposure to cyclicality, what is our exposure to companies with “high beta” or “high volatility”, it’s very small, we probably have the lowest exposure, despite having Naspers at that level, we probably have the lowest exposure to cyclical businesses in the country, on that stock market that is. By the way, what is the reason why we have Naspers at that level? Because when all is said and done this is a great quality company. We have a low in-price at it, we’re not about to sell this company. If you’re going into an environment that we’re talking about you just need to make sure that you’re not going to go and sell low. Now, you will sell low because some companies you’ll be looking at potential bankruptcy in cyclical industries. Naspers is not in that position, so we’ll hold this company right through but we’ll continue to have an advantage because relative to the market, to the index, relative to our peers, we have the least cyclical fund.
RYK VAN NIEKERK: I appreciate that but investors don’t always look at it like that. Investors look at one-year, three-year performance levels and base investment decisions on those, how do you tie those two together?
HLELO GIYOSE: That’s a great point because there are some companies and some sectors but I shouldn’t really say sectors because that’s more like a macro view, there are some companies that you have no business owning if you want to create wealth. You really don’t have any business owning a mining company if you want to create wealth, on one condition, that you have a three-year investment horizon or more by the way, it really should be five but let’s cut people some slack because some of them don’t have an attention span that goes further than three years. If you have at least three years and more, you really do not need to own a mining company. Why don’t you need to own a mining company? Because the level of movement in share price, of volatility, is such that you never quite time the bottom to buy in, you get in somewhere in the middle of an upswing or three-quarters up the upswing but then you tend to get out a lot lower than where you got in. Those companies, a lot of them, are wonderful candidates for bankruptcy in recessions, most of them just never come back. Now, tell me that’s the case with Naspers, if you hold it, even if you happen to have bought it higher, will Naspers come back? Take Naspers versus – pick a company – Murray & Roberts, Group Five, Lonmin, Implats, which one do you think will come back quicker?
RYK VAN NIEKERK: But Naspers is based on a Chinese internet company, which is under regulatory pressure, I don’t think they will be bankrupt but the performance in the short and medium term could be worse than some of the other big international technology stocks.
HLELO GIYOSE: Sure, it could slow down, gaming I think in a way is slowing down but think about it, this is the number one gaming company in the world. Think about it. Number one gaming company, its structural advantages are so strong that in its industry there will be many other companies that will fall out before it does. So look at it this way, that you are at the safer end of a bad neighborhood, which you’ve just pointed out, it’s a bad neighborhood going on in China but you are the Microsoft, you are the Amazon, who’s going to go down first Kmart or Amazon.
RYK VAN NIEKERK: We’ll have to leave it there, thank you Hlelo. That was Hlelo Giyose, he is the chief investment officer of First Avenue Investments.