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2019 Investment Views

Cutting out the noise

28 November 2018
Authors: Chris FreundHead of SA Equity & Multi-Asset, Hannes van den BergCo-Head of SA Equity & Multi-Asset, 4Factor

Chris Freund and Hannes van den Berg discuss the year ahead for equity markets.


Hannes: So, Chris, in 2017 we all waited for the ANC conference. In 2018 it was more of the same with Trump and his tweets and we got a new President, a new Finance Minister. Geopolitics seems like its back in the markets. I mean how do you manage through all these political events that are playing out in the markets globally and also in South Africa?

Chris: Hannes, greetings. So I reckon one of the things that we learnt in the chaos of South Africa of sort of 2016 and ’17 was actually to try and ignore, as far as possible, the political noise and focus on the underlying economic and market fundamentals. So that is what I have certainly been trying to do this year.

We have seen the sort of Trump noise that you refer to potentially impacting the underlying fundamentals in terms of global trade but my own view is that the markets are overreacting to the non-fundamental geopolitical noise and that the sort of underlying fundamentals around the world still remain reasonable and, indeed, in South Africa are slowly getting better. So look through it. Hold the line and look through it would be my sort of take on it.

Hannes: And what do you make of yesterday’s winners being tomorrow’s losers sector-wise, globally, also in South Africa?

Chris: Yeah. So it is very rare for a sector that is leading the market, bull market, to all of a sudden flag and for the bull market to continue, possibly with a new sector taking leadership. I don’t think I have seen that too often. So then you have to ask yourself the question, you know, what prospects for the IT sector that has clearly been the leader in the last couple of years and they have come back a lot and is it all over for them because, if it is all over for them, you have sort of got to think it is pretty much all over for this global equity bull market and we better prepare ourselves for a proper long-term down swing.

My take is that it is not all over for the IT sector. They have had a proper setback or a pull-back but the fundamentals still look reasonably good for them for a whole host of reasons (which we won’t go into now) and that I don’t really think there is going to be a new sector that sort of leads the bull market higher. When the bull market is eventually over, then the sector that is leading it will come back as well. So I guess we should probably talk about when we expect the bull market should be over but possibly come back to that later.

What I wanted to ask you about (I know you know more about this than I do) is the property sector. What is your outlook on that because the sort of property rental distribution growth has slowed down a lot and the shares have come back a lot? They appear at face value to be offering a lot of value. Should you and I be buying more of them now?

Hannes: Yeah, you are right. I mean this year winner has obviously been the resources sector and the dog has been the property sector, the darling for the previous few years, and these stocks are incredibly cheap at the moment. If you look at the dividend yields, some of these stocks are offering 10, 11% dividend yields. They are trading at NAV or discounts to NAV but equities, in general, are in my mind geared plays on GDP growth. I mean if you have strong growth, that is supportive of revenue for these companies.

We went through the resilience stable issue in January/February. That caused a bit of a derating in the sector to happen. Outside of the resilience stable, you know growth point and high prop and redefine those properties, unfortunately, are exposed to a South African economy where rentals and renewals in rentals are going sideways to down. The property market looks a bit saturated. We have got vacancies picking up. Growth has just been too strong and we need that to stabilise.

So, yes, these stocks look incredibly cheap just fundamentally from a bottom-up perspective but we need the dynamics in that sector to turn better or either go sideways and then start moving more positively. So, because of vacancies, because of the risk to the growth rate of these companies going forward, we are doing some work but I think it is still a bit too early.

Chris: So you reckon we wait to see the sort of fundamentals of the dynamics improve rather than try and front-run it because it might be a long time before it actually turns up.

Hannes: Correct.

Chris: Cool, got you. And so the other thing is almost this time last year you and I got hurt badly by Steinhoff and it caused us a lot of navel-gazing about our sort of approach to assessing corporate governance in our investments. It is not like we didn’t consider it before but we re-assessed everything we did. Can you just in a nutshell take us through the sort of changes or any change we have made in that whole area if you have got any examples as well?

Hannes: So when we pick stocks, we like to invest or allocate capital to stocks where earnings revisions are being revised higher, positive earnings revisions, at a reasonable valuation and the way in which we have truly integrated ESG into our process is to ask ourselves, from a bottom-up fundamental perspective, are these earnings revisions sustainable and are the valuations that we are seeing reasonable and are they incorporating the ESG concerns?

The way we do it simply, from a macro perspective, we make use of universe screening MSCI data, ISS recommendations. We have got software tools where we can evaluate our portfolios, evaluate reputational risk for certain stocks. Those are all sort of external data-points and news flow and information that we use and, from a bottom-up perspective, the analysts present 1 or 2 or 3 slides on the concerns from an environmental, social and governance perspective and then we evaluate, we engage and then also on an overall portfolio level how are we positioned with regards to ES&G score. So I think, yes, that has really been one of the big focus points over the last 12 months and it will definitely be going forward about how do we truly integrate that into our fundamental decision-making when we pick stocks.

Chris: I mean I think that is the difference, hey. I mean we used to have or we have always had analysts presenting stocks to us but we have never had it right there in the decision-making process one of the key things we look at – are there governance or environmental or social aspects that may negatively impact our earnings revision expectations or valuation expectations, right there and, if so, don’t do it.

Hannes: So, Chris, from here, I mean going forward into 2019, balanced fund, equity funds, our views on some of the currency, inflation, interest rate factors, what are your thoughts over the next few months?

Chris: You ask the question well because they are all linked. They are all linked. You know your view on the currency has to line up with your view, as you say, on inflation and on interest rates and on the markets actually. They are all inter-linked.

So markets have come back a lot in October. My own view is that the markets are overreacting to a perceived slowdown in global growth. It is slowing (don’t get me wrong) but it is slowing from sort of above trend to somewhere near trend and it appears to be a long way from below trend growth. So that would be my first point and then there was a bit of anxiety about the Fed getting – sort of making a policy mistake and pushing rates a bit too hard and I don’t really see inflationary numbers forcing the Fed’s hand too bad.

With respect to your currency question, one of the things that is quite interesting is that in the sort of October bloodbath the emerging market currency didn’t get hit. They previously got hit. They got hit before this, a couple of months before that but for very idiosyncratic or country-specific reasons – Turkey, Argentina, etc. So at some stage there is going to be a proper slowdown in global growth. It is not this year and it is probably not next year (2019). It is probably 2020 and at that point the rand and all its mates, the emerging market currencies, are going to take a hit, as will all risk assets generally. Emerging market currencies, [just] the rand is just a risk asset.

So I think we have got a bit of time still before the currency takes a leg down but not too much time. It is sort of the right time to be thinking about taking money offshore but possibly, you know, you have got a bit of time.

Then on the interest rate story – therefore, I don’t think that the inflation numbers are going to surprise the Reserve Bank on the upside. In fact, we think the inflation numbers are going to surprise on the downside. Therefore, we don’t think rates are going to go up very much. They may go up once, possibly twice, but we don’t even think it will be twice.

So fairly sanguine outlook still for a while, for another sort of (I don’t know) 6-12 months or so on a macro level and then it all comes down to whether you and the research team can pick decent stocks. (Laughter)… So on that score, I am going to pass the ball back to you and say, you know, which stocks do you think – which sectors or stocks do you think that we should position our clients’ cash in?

Hannes: Well, I think, with the backdrop like you – I agree, the backdrop should be quite supportive going into 2019 and that should do – emerging markets tend to do well when you have got decent global growth and specifically the resources space, stocks like Anglo American, BHP Billiton, South32 are some of the stocks that benefit from tight supply/demand dynamics.

There will – should South Africa start to bottom out and our economy starts recovering, I mean we have got a lot of promise about investment coming into our country. It looks like our state-owned entities are getting restructured and, when that leads to more confidence coming back into our economy, I mean our banks are screening incredibly cheap at the moment and the earnings dynamics of some of the banks, FirstRand specifically…

Chris: Sorry to interrupt but I agree that the sort of SA-specific economic fundamentals are slowly but surely improving at a fairly slow pace but there is one little layer of improvement getting added to the base quite often. It would be uniquely South African to have our sort of nascent, mild upswing coshed by the global downswing if it happens.

Hannes: Correct. So resources should do well and in South Africa, as you say, our retailers, we don’t have a big overweight in retailers but we are certainly doing a lot of work in the retail space at the moment because they are geared to a GDP recovery and they are well-run businesses with healthy margins and good free cash generation. I mean dividend yields at 5%, PEs at 10, 11. Should we just get some form of a recovery going through our economy with volumes actually picking up, a bit of a tailwind from inflation, the revenue line should be quite supportive…

Chris: So which – just quickly, which stocks?

Hannes: Mr Price still screens well. A stock like Foschini screens well for us. In the insurance space, Mutual and Sanlam screen well. They are looking interesting and I have mentioned some of the banks. So there are definitely enough opportunities out there. We just have to be responsible in the way in which we allocate capital to those opportunities.

Chris: So, in summary then, you and I are on the same page here. We basically – it has been a weak 2018, weaker than we think it should have been and it is too early to get too defensive in managing other people’s money now. Keep the sort of sales still up to try and capture returns rather than sort of to continue the sailing and batten down the hatches to sort of protect what you have got. You know that is what 2019 looks like to us.

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This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is not an invitation to make an investment and should not be construed as advice. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Investec Asset Management.In South Africa, Investec Asset Management is an authorised financial services provider. In Hong Kong, this content has not been reviewed by the SFC and is issued by Investec Asset Management Hong Kong Limited. In Singapore, this content is issued by Investec Asset Management Singapore Pte Limited (Co. Reg. No. 201220398M).

Chris Freund
Chris Freund Head of SA Equity & Multi-Asset
Hannes van den Berg
Hannes van den Berg Co-Head of SA Equity & Multi-Asset, 4Factor

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