Investment Insights: SA Equities – uncovering the gems
By Nedgroup Investments
South African equities have been one of the standout performers in global investment markets this year. Is there still value in the market beyond the resource stocks that have driven the performance of markets to date? We chatted to Murray Winkler and Dwayne Dippenaar, investment managers of the Nedgroup Investments SA Equity Fund.
Laurium is fundamental bottom up investor. This means we do a business and financial assessment after which we value the business, but this is overlaid with a macro-economic overview.
What do we think will happen one year from now? Looking at the global economic recovery, the cyclical recovery as very much intact. We expect global growth at 6% this year. This growth will likely continue into next year although at a slightly lower rate of approximately 4%.
In South Africa, although we haven’t had as much fiscal stimulus, the stimulus provided by commodities has been helpful and we expect a growth rate of around 3.5% this year. This might rise in the shorter term but is likely to drop to around 2% next year due to the significant structural impediments in the economy.
The 10-year yield in the US is very important to markets and it is currently at 1.5% but our view is that it will get to around 2%. There is some concern that the speed of movement could hurt markets, but we believe at around 2% this is not a problem for markets and they could grind higher even at 2.25%.
In terms of South African short rates, we expect one rate hike in the first half next year taking prime to 7.5%. On the bond side we have had a view that the 10-year SA bond will be about 9%. It is currently close to that but with what’s going on it could get a bit stronger in the shorter term.
Currency is always very difficult to call. Looking out a year from now, we see R14.75/$ but it could be a bit stronger with the cyclical rebound we are seeing at the moment.
The fiscal stimulus in context
Fiscal stimulus in markets around the world has been much more significant in response to the Covid pandemic when compared to the fiscal commitments made in the financial crisis of 2008 (which was broadly 5% of GDP). Last year, the US had huge stimulus of around 13%.
Furthermore, since the Democrats came into office, there has been a further 13% injected this year. This means the US economy has had a massive 25% of GDP stimulus this year, in addition to a monetary stimulus which is why we believe the US economy will remain very strong this year and for the next few years.
Negative real rates are very positive for markets, but the big risk is inflation. We project that inflation will probably get to around 2%. This is generally accepted as consensus in the market.
How has this stimulus played out?
From February this year, there has been an increase from 4% - 6.5% predictions in US GDP growth. There is a 3.5% additional growth forecast for US GDP over the next few years. This is driving very strong numbers. The big risks are inflation – everyone is talking about it. It’s hard to call. Generally, inflation is expected to spike before coming back down again to 2.5%, 12-18 months out. The same applies to Core inflation. The 19 voting members of the FOMC, agreed that there would not a be a short rate hike until 2024. We think it will be brought forward a year, but that’s what they have been saying.
The backdrop for market remains good and our view is that we will see earnings continue to surprise which will keep markets up in the medium-term.
The Local Case
On the local side, of course we have many structural problems to consider. South Africa’s already-low economic growth was knocked off-course by the Covid pandemic. In terms of growth we believe we will be lucky to get 4.5% this year and this recovery will vary significantly per sector. The are also some big structural impediments to this.
Agriculture is doing extremely well and will be about 20% above the 2019 figures. Mining also doing really well but electricity, transport and tourism are all struggling.
In terms of the fiscal outlook for South Africa, the debt to GDP ratio has shifted alarmingly but there were pre-existing conditions to the Covid pandemic that exasperated this.
The current account is in a very good space with a big surplus, mainly due to the strong performance of local commodities which are at price levels we last saw in 2011. Our debt to GDP projections will likely perk at below 90%. Expenditure is still in excess of revenue and needs to be addressed.
But the good news is in the commodity prices which are trading at extremely good prices which is excellent for South Africa. Commodity prices are almost back at the levels we saw in 2011.
What does this mean for our current account?
Looking at our current account ratio to GDP since 1960, we have been running a current account deficit of around 4% for the past 15 years. We very seldomly get to surplus. However, we think that for the full year this year we will end up with a current account surplus of around 3%. The last time this happened was in 1987. This is very positive for South Africa and is one of the reasons why the Rand is holding up so well.
Revenue collections have surprised on the upside as well. The October medium-term budget predicted a shortfall of around R400m and the actual shortfall was around R175m. For this year, things look a lot better.
Last year weekly auctions in the bond markets were R10bn issuance. We have just been revised down to R6bn by Treasury so it’s very positive. The supply of bonds on this market is a lot less. A lot of people are very negative on South Africa. The structural issues are still very much in place but we think cyclically we are doing well and that we will continue to see earnings surprises.
Importantly, what we need in the next 12 months are structural reforms. We have seen encouraging developments in the electricity side recently which will hopefully be very positive in terms of fixed-investment spend.
To summarise, we believe a cyclical recovery is in place for South Africa which creates very interesting opportunity in the equity markets which we are well-placed to take advantage of.
Where are the signs of value in South African equities?
We see the main sources of return being in global consumers, healthcare, financials and resources.
In terms of global consumer, we have a large holding in BAT and we still think looks extremely attractive with share buy backs expected at the end of this year. We also have a large holding in Naspers. While much of this value is still driven by Tencent, we think earnings can continue to grow over the next few years at over 20% and there is a lot of opportunity for revenue growth. On top of this we are also buying Naspers at 50% discount, so this remains a cornerstone of our investments.
Healthcare is looking very attractive at the moment and we think they will recover post-Covid.
SA Financials have performed well for us last year when we had a large position in the Sa banks. We have now switched a lot of this to insurers who we think are looking very attractive.
Resources: We think that the platinum group metals are well supported in the medium term. Diversified are also well supported but we are a bit more cautious there in anticipation of a slowdown in China next year.
The portfolio is currently extremely well positioned to take advantage of the opportunities in these sectors.
Watch the full webinar for a deeper dive into the portfolio composition of the Nedgroup Investments SA Equity Fund and the potential Laurium sees in South African Healthcare and Insurers.