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Investment views

Podcast: Taking Stock in 2018

19 July 2018

Hannes van den Berg, Portfolio Manager at Investec Asset Management, discusses the major topics both at home and abroad in the lead up to the Taking Stock client roadshow.

 

Transcription

Lindsay Williams: Twice a year Investec Asset Management goes on the National Road Show. The National Road Show is called Taking Stock. In the early part of the year, normally the first week in February, it is the really big event where clients and CFAs and so-called professionals are invited along. The July/August affair is just for the professionals. The clients don’t tend to come along but, whoever is attending, it is a very, very important event. I have been involved in three over the last four, not this one, so this makes it even more important for me to get a sneak preview of what is going to happen. It starts at the end of this month in Port Elizabeth.

On the telephone now somebody who is going to be a keynote speaker at most of the events is Hannes van den Berg, who is a Portfolio Manager at Investec Asset Management based in Cape Town. It was a difficult few sessions that we had in February, Hannes, if you remember, because during that first week we had the first sort of Wall Street wobble and we were talking about it. Things have calmed down a little bit since then but, nonetheless, not a lot easier this time I don’t think.

Hannes van den Berg: Good evening, Lindsay. It definitely is not. I must say I am incredibly frustrated with what we are seeing in markets. You mentioned Taking Stock earlier this year. Since then, we have pretty much had a sideways moving market. I mean we can talk to the individual sectors. The resources sector is up close to 9% but you have got the banks and the retailers, especially the retail index is down 17% year-to-date. So it has been a market that has gone sideways but you have had big moves inside sectors.

I think, if I can summarise it, the way I am feeling now and why I am frustrated is me in this mind-set of how do we balance an improving business cycle with global growth in emerging markets and businesses delivering good earnings, decent earnings growth potential from companies – how do you balance that with an intensifying trade war that we are seeing? I mean you wake up every morning and you wonder what the next headline is that you are going to read.

Lindsay Williams: Yeah, indeed. The other thing that worries me somewhat is the way that we have dislocated ourselves somewhat from global trend. For example, you might, not just for one day or one week but for two months, see the developed world markets, e.g. the S&P 500 or the Dow Jones or the Nasdaq, doing one thing and the JSE’s All Share Index or Industrial Index doing something completely different and I don’t know which one is leading and which one is the laggard. For me, it is incredibly frustrating to see, for example, now, as we pre-record this interview, the S&P down but our local market up. What is going on? And also our economic cycles, our macro-economic cycles completely out of sync in my mind.

Hannes van den Berg: I agree with you, Lindsay. Investors in equity markets specifically, I can understand why they are frustrated with the returns they have seen over the last call it three years where the market has just gone sideways. So you have to live with all this volatility but you don’t see the returns. You know, you tend to think that equity markets outperform over the medium and long term and you have to live with its volatility but you don’t see the returns coming through.

To your point, I think we are still seeing a lot of expansion in the US. The US, as a market leader, is growing very strongly. Their Federal Reserve Bank have to hike rates because they have got things like wage inflation that is starting to come through. Where the oil price is now, base effects and a strong oil price, inflation must be front of mind for them. So they are going to probably continue on the path that they are and the [dots] that they have indicated and the market have priced that in.

The Euro area was very strong initially. Then we saw some weak data coming out, especially in Q2, and people thought it is weather-related and German manufacturing data, etc., that was weak, some political concerns and we still read Brexit headlines every day. So there is definitely uncertainty in Euro area but I seem to think that has played out and bottomed out so maybe that goes sideways and doesn’t deteriorate from here. China, the data we saw on the margin, maybe a few basis points GDP growth lighter than what the market was expecting but it is still about 6.5, 6.6% GDP growth.

The thing is for South Africa, an emerging market economy, we tend to like synchronised growth more than we like specific leaders, like the US is leading at the moment. So we actually want all the markets to be a tailwind and to provide a tailwind for cyclical recovery and for global exports to be strong because we do export a lot of commodities. That is why the trade war is obviously not ideal for us at all and how it is playing out.

Lindsay Williams: Yeah, it really is and it looks as though it is going to continue to play out. At the moment, it is just a few shots across a few bows and a few of those shots have hit the mark but it really does look as though it is going to get worse before it gets better, especially considering the words that came out of Helsinki in the last couple of days, which were quite extraordinary.

You mentioned commodities, the resources sector of the JSE Securities Exchange being up 9%. You then said retailers down 17%. Maybe we should start with the resources sector and what you are going to put out to the advisors and the clients at Taking Stock. What is your message going to be, starting with commodities?

Hannes van den Berg: You know me, Lindsay. I am a ‘glass half full’ kind of person. So we tend to think that there will definitely be a lot of rhetoric going on around trade wars and we need to stay close to that and monitor that and also understand if you slap tariffs onto some global trade and prices go up, that affects volumes. So we need to understand that there is a knock-on effect. If that rhetoric doesn’t say in this tit-for-tat environment where one country announces something and another country retaliates, then the actual global growth cycle still is intact for us. We think it is still too early to panic. We think you should stay on the risk-horse for now, depending on how the trade war plays out.

Back to commodities, I tend to always think that strong commodities leads to strong emerging market currencies, leads to lower inflation, leads to interest rate cuts, leads to stronger growth. From a supply/demand perspective, I still think for a lot of the bulk and base metals some of the Chinese demand is still strong. The steel cycle looks intact. I think, if you look of manufacturing of steel in China as well as in the rest of the world, you see the clamp-down on pollution and the use of waste material, that is still ongoing in China and that is giving some of the Chinese steel mills healthy margins and, as long as they have got these healthy, strong margins, there will be demand for quality iron ore.

So we tend to think that the diversified miners, the Anglo-American’s, the BHP Billiton’s of the world are still in a good space. These mines have got good margins, generate a lot of cash flow and you find them at a reasonable valuation. We like companies where consensus earnings expectations are being revised higher and you see that for both Anglo-American and BHP Billiton.

Also Sasol is a stock that we quite like, with the cash flow profile of that business that will change over the next 2-3 years as their Cracker Project ramps up in Louisiana. That project, from sucking up a lot of cash because of capex spend, will turn into producing cash flow back to the company. We think that will materially change the earnings profile for Sasol going forward.

On the retail side, we started the year with a lot of positive sentiment. We joined the emerging market party because of political change that happened in South Africa. The problem is that everybody has been at that party for quite a while and, with the global backdrop deteriorating and becoming a bit weaker, we run the risk of joining that party a bit late. So the sentiment, business, consumer confidence is quite strong. The correlation between business confidence and job creation is quite high. So you want business confidence to stay strong, which should lead then to job creation. Unfortunately, we have seen that turn downwards, Q2 specifically.

So a lot of our retail companies specifically, especially the cyclical retail companies, have seen a lot of negative earnings revisions and every management team we speak to are telling us they are not seeing the recovery, haven’t seen it, it’s still not coming through. So, unfortunately, on that sector, we need to – and now we are dealing with land reform and NHI and Eskom and, as I have said, a weaker global backdrop. So we have continuously got issues that are not helping business or consumer confidence, which doesn’t lead to lending, it doesn’t lead to capital spending, etc.

Lindsay Williams: Let’s go back to commodities before I mention my thoughts on the retail sector, which you have sort of embellished the fears that I have had for quite a while now about certain of our retailers but, going back to the resources sector, the commodity price recovery, it has been in place for a while but it disturbed me to notice that the copper price, for example, in a very short space of time has fallen over 20%.

I was talking to a commentator yesterday on this radio program and I said, you know, is this sometimes a precursor to something a little bit more serious, i.e. the start of a global slowdown and maybe even a global recession, which a couple of your colleagues have spoken to me about in different forums over the last 2-3 months? They say it could be in – you know, within 1.5 to 3 years a global recession could be a reality for all of us. Obviously, global means South Africa and the rest of the world even though we are out of sync when it comes to economic growth. Do you worry a little bit about the commodity prices coming down?

Hannes van den Berg: Yeah, I think Dr Copper has always been a bit of a leading indicator. Overnight, over the last two days, you also saw the oil price pulling back quite strongly in two or three trading sessions.

We hear rumours about [big] derivatives unwinding and guys who had big positions on copper but I think, if I look at the mining sector and what they have gone through, in 2015 Glencore was trading below £1. It was a penny stock. Anglo-American went into break-up mode [about] restructuring their balance sheet. I think, since then, these companies have managed to cut back on costs. They have managed to increase production, which means that the average cost of producing a unit is a lot lower than what it was pre-2015. Commodity prices have managed to recover from the lows we saw in 2015. So, from a balance sheet perspective, from a free cash flow perspective, from a margin perspective, these companies are in a much better position than they were 3-4 years ago.

Now we have seen this incredible rally so how much more can these commodity prices go? A lot of that will depend on where we are in the growth in the cyclical environment, in the cyclical backdrop. I tend to think that, with China strong, there is still a bit of a tailwind for global exports and that this cycle and where we are in the cycle is still a very powerful driver. I know people are trying to forecast the next recession and trying to understand the probability of a next recession and when that will happen but, from where we are in the cycle, from a supply/demand perspective, as I say, these miners are a lot more disciplined, there is limited new supply that has come on and there are structural deficits emerging in some commodities.

So I tend to think that the fundamentals of, for example, the copper price and the oil price. From the supplier side, there is still this value over volume discipline in place and the demand side is underpinned by what everybody feared to be a Chinese hard landing is actually quite a controlled Chinese soft landing and, as a I say, the US is growing incredibly strongly. So from a supply/demand perspective, I think the growth cycle is still intact for commodities. People who fear the liquidity that gets withdrawn, interest rates that are going up, the US hiking and sometime in 2019 the ECB will also start hiking so people moved from QE to QT (quantitative tightening) but positive growth generally trumps negative liquidity.

So what we saw in 2005 to 2007 was interest rates did go up but, if you go and you plot the commodity prices, the commodity index relative to interest rates because interest rates had to go up because growth started coming through, that is a good environment for commodity prices, so we are still constructive on commodities like copper and oil and, as I said, iron ore.

Lindsay Williams: Good. Well, let’s hope so and let’s hope that what we have seen in the last 6-8 weeks is merely a northern hemisphere summer phenomenon because that is where most of the prices are made. Obviously, there is Shanghai, etc., but it is still the European markets that make the prices and so, yeah, maybe it’s just a seasonal factor.

You have spoken about retailers. I haven’t got a chance to give my views and that is very briefly when you walk around shopping centres, I see a few people around but I don’t see people spending a lot of money. You go to the V&A Waterfront, there’s quite a few tourists but I don’t see a lot of locals there with shopping bags. I see them going there and walking around because it’s a wet Saturday afternoon, something like that, but I don’t see people spending.

We haven’t spoken about financials; we haven’t spoken about banks and, obviously, that is linked to retail because people have to transact and therefore that is where the banks make their money. What do you think about those sectors because the banks have had a torrid time recently?

Hannes van den Berg: …Lindsay, we need activity to pick up. I think to a certain degree the South African consumers particularly have degeared. So, from a balance sheet perspective, I think the consumer is in much better shape. We constantly see wage negotiations going on and wage increases being above inflation.

I always tend to think that inflation is one of the biggest variables that you have to consider when you look at the effect of inflation of consumer spending. It’s a very important consideration and I think there are certain segments of our market where, for example, food inflation has been below the number that we just see as the inflation number. I think for some segments of the market inflation and food inflation specifically is down to 2%. Those segments of the market potentially have wage increases of 6% and higher. So in real terms there’s more money in the wallets of those consumers.

If we look back at what we have seen over the last six months, we have had a sensible budget; we have seen changes to cabinet; we have seen changes to state-owned entities and boards; SARS replacements we are seeing, but we need confidence to come back. We need all the variables and the uncertainties to be addressed and for consumers to have that conviction and willingness to spend when they go to the shops but also to lend and to borrow, banks to lend and consumers to borrow so that they can use that money to buy vehicles, to renovate their houses and, through that, activity should pick up.

So I tend to think that NCR (the National Credit Regulator) stats indicate that there is some appetite coming back into the economy from the banks’ side but it is slow. I tend to think that we need to look at capital spending and capex and that will also be driven by business and consumer confidence. Then, as I say, as long as the currency does not blow out and when it went to R14.00, obviously, inflation fears came back and now it is back to R13.20, so if we can control our currency, that also again links back to the commodities cycle. If our currency strays around here and then stronger, inflation shouldn’t be too much of a problem.

Having said that, I do think that the hurdle for our Reserve Bank to cut interest rates again from here is quite high and that the next move potentially will be an interest rate hike. I don’t see it in the near term but, going forward, I don’t think we will get a tailwind from interest rates but we need consumer confidence to help us to see spending. We still think that, with the global growth cyclical backdrop and should we see synchronised growth back on with, as I mentioned earlier, the macro picture being supportive, that will be good for emerging markets and growth stays above trend, that will be good for us. In that environment, as the confidence comes into our economy, going into 2019, we might still see a recovery in sectors like the retail and the banking sector.

Lindsay Williams: Let’s hope so. We started the introduction to this chat talking about how difficult a time we had with the market action at the Taking Stock, the first Taking Stock of 2018. Just summarise what you are going to be saying at the second Taking Stock, which starts at the end of July. What is going to be your overriding message?

Hannes van den Berg: I am going to agree that markets aren’t cheap. If you look at the multiples that we get on our index and we can go through the sectors, markets are not cheap but they are definitely more attractively valued than they were maybe 12 or 24 months ago. I mean a lot of people say that the markets are too expensive; you shouldn’t get involved. I don’t necessarily agree with that.

I think it is definitely more attractively valued but we focus – from our investment philosophy perspective, we focus on companies where we see earnings being revised higher, positive earnings revisions and we still find opportunities like that. This philosophy also helps us to avoid companies where potentially you might have a value trap because earnings keep on being revised lower and we still find hard conviction ideas that blend quite well in diversified portfolios. As I said, resources and, when the opportunity comes in the banks and the retailers and we see earnings expectations bottoming out and turning more favourable and positive, we will definitely make use of the opportunity to allocate capital.

Then we still have global industrial rand hedge companies, like Naspers and Richemont, that are still looking attractive and where consensus are revising their earnings upwards. So in those buckets we still find opportunities. These are uncorrelated opportunities and therefore we can still build nice, diversified portfolios, which we believe will outperform over the medium and longer term.

Lindsay Williams: Hannes, I like your optimism. Thank you very much for your time this evening. That is Hannes van den Berg, Portfolio Manager at Investec Asset Management in Cape Town.

 

 


Important information

 

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. The value of investments can fall as well as rise and losses may be made. In South Africa, Investec Asset Management is an authorised financial services provider.

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