Given that South African equities seem to be very unloved, Murray Winckler, Co-founder and Senior Portfolio Manager at Laurium Capital, answers the question as to whether now if the right time to buy SA.
Over the last five years, the ALSI was up 2% in Rands and down 2.5% in Dollars, so has done well in comparison to cash. The S&P is up 11% per annum and the MSCI World Index, also up about 7% per year for the last five years. To put SA’s performance into perspective, over the last 15 years, the S&P relative to the JSE ALSI has beaten SA by 70% in Dollar terms. If we remove the US from this performance, South Africa’s index in Dollars has matched the rest of the world, including Europe, Japan and Asia.
So, how have we managed to match the rest of the world excluding the US? We tend to forget that South Africa is one of the more diversified indices globally. Only 24% of the performance or exposure of the ALSI is linked to domestic South Africa. The rest of it is diversified with a lot in EM (Naspers and Prosus) and DM. The Capped SWIX Index, which is a more diversified index, has a 37% exposure to domestic South Africa.
In the long run, earnings drive markets. If we look at the last 15 years, the earnings in Dollars of the South Africa index has gone up about 25% - 30%. If we compare this to the MSI Ex-US, our earnings are closely correlated to the rest of the world because of the diversification. Projected earnings for South Africa for the next three years is that we grow at about 5% compound per annum in Dollars. We think it will be less, closer to zero. The rest of the world ex US is projected to grow at about 12%. Two years ago, SA was projected to grow by 20% in dollar earnings for the next three years – this has collapsed.
The ALSI is currently trading on a 12-month forward multiple of 13 times. The ACWI Ex US is about 15 times. Historically, we’ve traded at similar levels to the ones we’re at now. Over the last 15 years, we have traded at an 8% – 10% premium relative to ACWI Ex-US. Given the bleak outlook for SA Inc, we are down to about a 15% discount relative to the index, a substantial derating.
The US dollar is an important driver for EM and non-US markets. From mid-2014, the US dollar has been unbelievably strong and has appreciated relative to other currencies by about 20%. A strong Dollar tends to hold back the Dollar earnings of South Africa. When the dollar weakens, the Dollar earnings of South Africa do quite well and vice versa. Over the next few years, we could be entering a period where the Dollar is relatively weak or not so strong, which would be quite decent for Dollar earnings, which applies to Europe and South Africa. If that is the case, resources should do well, we may see some inflation in the US and SA Inc will probably be a beneficiary of that.
SA equity market outlook
We think we’re going to be 10% GDP negative this year with a budget deficit of about 15% and at the 85% debt to GDP level by next year and rising. Our big problem is our cost of funding, which is at 10% versus the US at 1%. South Africa has a major financial problem going forward, which the markets are anticipating, but it’s going to be pretty tough. The forward multiple for the SA market for the last 7 years has averaged around 12.5 times. During the COVID-19 crisis it was as low as 7 times but has bounced back to around 10 as earnings have been revised downwards. We think the market has overreacted on valuations. We’re very worried about property as a whole and retail, while banks look attractively valued and are well capitalized. We remain underweight in the SA Inc component of the Capped SWIX.
SA offers diversified global exposure
Using the Capped SWIX as our benchmark, Naspers/Prosus is 16% of the index. Naspers has gone up 13% in US Dollar terms, compound per year, in the last five years and we expect it to do very well over the next 3-5 years. The Global Consumer bucket is 11% and contains British American Tobacco (BAT) Reinet with valuations of 8 multiples and 7% dividend yield for BAT. AB InBev and Richemont are also in there. Metals and mining is 20% and is a sector that we think will do well. Gold is 5%. While we don’t like gold, if the Dollar weakens, it could go quite a lot higher. We are underweight in our funds to domestic SA, running at about 25% exposure and containing quite a few banks, Growthpoint and a few industrials that we really like, such as Transaction Capital. The other Rand hedge is a lot of the international counters, including 91 asset managers, Quilter and Mondi who will move very much in line with the rest of their international businesses.
Is now the time to buy SA?
Relative to the US and the MSCI Index since mid-April, the South Africa Index in Dollars is already up 12% relative to those indices. So, maybe it’s already started. Looking forward, we think it doesn’t look too bad.