Investment update – June 2020
Nervousness and negativity abound at present. Our conversations are filled with the virus; the effect on the economy; corruption; politics; prescribed assets; racism; expropriation without compensation; rating agency downgrades; Rand weakness; etc., not to mention the impact all this is having on our investments. Yet our portfolios are at or near record highs and global markets are also at pre-Covid levels. The market is disconnected from economic reality. How do we traverse this terrain?
Obviously, we don’t have the answers, share many of the concerns and don’t clearly see the catalyst for change. We fear that much of what we see is empty political posturing that will again not amount to much. We hope that the capitalists still have some influence in our world, although they too have a lot to answer for. Our business has little to offer in trying to change the world. Our focus is on looking after our clients’ financial well-being – tilting our portfolios away from risk and towards opportunity.
Much of the change we see in SA is structural and of grave concern, as the infrastructure has been hollowed out. There is however, a pattern to many things that is cyclical and we have seen them in a different form before. Investors emotions are linked to markets and the negativity in the press adds to the mood. It is a feedback loop where everything affects everything. Politics, corruption, the erosion of the moral fibre, divisive racial discourse, the devastating effect the virus is having on the world’s economy – these things affect our mood, which feeds into markets, exchange rates and our willingness to take risk and be expansive in our thinking.
Market indices are again dominated by the technology shares (Facebook, Apple, Amazon, Netflix, Google and locally Naspers). The 5 largest shares in the US constitute 20% of the S&P 500 Index. Naspers (and its recently unbundled Prosus) constitutes 35% of our top 20 shares (by size). Add in British American Tobacco and Anheuser Busch and these three companies make up 61% of the top 20 by size. We are cautious of the heavy weight shares at this phase in the cycle as they make the indices risky. Any trouble in these large shares will have a great impact on markets.
The average is again made up of high and low risk positions, expensive and cheap shares. If we look beyond the very large shares dominating the index, a different reality emerges. Small and mid- size companies have been neglected by investors for many years. These companies are well priced and the risk of significant losses is lower.
Confirmation of this is found in various places. Share prices of many, formally blue-chip shares have collapsed between 80 and 90% from recent highs. Price / earnings multiples and dividend yields are at levels last seen in 2009. Directors are buying shares in their own companies – very rare, they are normally net sellers. Corporate action is on the rise – companies are raising cash, paying off debt, rebuilding their balance sheets.
In addition, many companies are delisting – the insiders cannot resist current, low prices. Companies are taking the opportunity to reduce costs – landlords and labour are on the back foot for the first time in years. Sadly, many jobs will be lost in the process. However, lower costs will lay the foundation for future profits.
Good returns come from the right starting point – we want to buy low and sell high. We are at a low point. Of course, we don’t know how low it may go or when things may begin to turn. Our sense, judging from factors mentioned in the previous paragraph, is that we don’t have much longer to wait.
At market tops we find investors cannot imagine anything going wrong – they expect the good times to last forever and will not sell. At market bottoms, we find the exact opposite, they cannot imagine anything ever going right – until they do. We can speculate as to what may change (more arrests by the NPA, shelving SAA plans, the low oil price feeding into profits and the balance of payments, the dollar weakening, etc.). One area of common concern at present is the valuation of the currency. The Rand (and all emerging market currencies) is weak relative to historical levels and compared to the more solid currencies. More accurately, developed market currencies are strong compared to emerging market currencies. There is a cyclical tendency for emerging countries to outperform and then to underperform. We are overdue a reversal of this cycle, but accept we can’t time the tipping point or predict what the catalyst to the change in direction might be.
Triumph of the Optimists: 101 Years of Global Investment Returns – a collaboration by Dimson, Staunton and Marsh, is a book published in 2002. When one looks back over time, we lurch from crisis to crisis and yet stock market trends are relentlessly upwards. The major conclusion from the book is that investors extrapolate from recent experience. In tough times, we are unable to imagine a positive outcome until after it has materialised.
Quoting from Michel Pireu’s article in the Business Day of 7 July 2020, “unprecedented events occur on a regular basis… The one charm of civilisation destroying events is that you don’t have to worry about their impact on your portfolio. It’s the bad … events that you need to prepare for.” We face risks and uncertainties and “the usual advice is simple enough: avoid making emotional decisions…, diversify…, stay invested…, identify challenged sectors early (airlines, hotels), be wary of debt (really?) identify potential new winners (?). If none of this seems particularly useful, …Ben Hunt at Epsilon Theory…believes failure of nerve, hesitation, being unable to shift into a defensive shape and a lack of imagination make up the complete…list of reasons for losing an important game. The last of these – a lack of imagination – is the most common and most damaging of the four… the greatest risk is a failure of imagination in understanding how the game might fundamentally change… you don’t have to change anything in your fundamental investment philosophy … because these are well-known and well-discussed event risks… if you’re going through hell… don’t stop. Whatever you’ve been doing? Keep doing it. With …time you will survive and come out fine on the other end”.