Is there still any value in the market?
- We are a resource-based economy, which is now working in our favour as commodity prices are very high
- The gap between import and export prices is extremely positive and is driving the trade balance surplus and Rand strength
- Valuation continues to look compelling as a result of the recovery in profits driven by the resource sector
Anthony Sedgwick is a Portfolio Manager at Abax Investments, the managers of the Nedgroup Investments Rainmaker and Entrepreneur Funds. Anthony discusses whether there is still value in the market.
The JSE has broken out after doing nothing for 6+ years
For a long time the equity market has tested the patience and trust of South Africa investors. The ALSI has been trapped in the range between 50 000 and 60 000 since 2014. There was some respite in 2018 when Cyril Ramaphosa was elected, but this really did nothing. The Covid crash is on record as being the fastest and most severe equity market crash globally, but also the fastest recovery. In the context of this recovery, many investors are wondering if they should be reducing equity exposure or retaining what they’ve got.
SA Economic outlook
There are five factors that have been structural, problematic areas for South Africa and which are still largely intact. Debt is unsustainable and getting worse with no GDP growth or plan. There is still political instability, limited corruption accountability and little economic policy certainty, but progress is being made. There are signs of an accelerating and broad-based economic growth, but what is the longevity? There are some green shoots in terms of the capital investment cycle and improved business confidence with indications looking promising. We need to see increasing employment numbers and improving consumer confidence. Off a very low base, consumer confidence at the end of 2020 was showing signs of improvement.
We’re feeling, however, more positive than we have in five years. In April 2021, if you consider these five factors, the news is better than in prior periods. The foundation stones of our economy are as a resource-based economy and we have a very rich natural resource heritage, which is now working in our favour. This is because many of these commodities are at very high prices. The key commodities are the PGM metals of palladium and platinum as well as the lesser known rhodium, iridium and ruthenium. Gold is less important, but also at a very high price. More importantly, iron ore, manganese, thermal coal and commodity prices, especially maize are all, in Rand and Dollar terms, at very high levels and so our commodity exports are flying. Against that, our major commodity import is oil. The gap between import and export prices is extremely positive and is driving the trade balance surplus and the Rand strength. This is important as these sector have high levels of employment. Could this be sparking a trickle-down effect of where the resource sector starts it, but it rolls into other industries that support the mining and production activities?
Forward valuation is attractive
In context of how much the market has recovered, valuation continues to look quite compelling as a result of the recovery in profits that we’re seeing. Arguably, this has been driven by the resource sector. The PE of the resource sector at mid-single digits looks very attractive despite the huge run we’ve had. These businesses’ market caps are multiples of what they were a few years ago and we’ve done well out of our exposure to them. The confidence we have in retaining them is that the approach taken by management is on strong balance sheets and no desire to squander shareholder money by investing in expanding production, but rather on paying surplus capital out to shareholders. There is no alternative source of yield, so it’s worthwhile having some exposure to the market.
Rainmaker overview since September 2020
In September, the Fund’s mandate changed to allow 30% to be invested offshore. We moved quickly to make some progress (±15%) to establish an offshore position. The ongoing strength of the Rrand, driven by trade balance has been very strong and we used this to continue to gradually increase the non-SA portion of the Fund, which is now at ±22%. 20% is in direct equity and 2% in cash. Drivers of performance will be from Naspers/Prosus, which accounts for 13.5% of the Fund. British American Tobacco and Reinet are a big component at 9.2% as are banks at a similar weighting. The resource sector is cumulatively just less than 30%. We’ve got 20% direct offshore and domestic SA financials and industrials are also a big component at 18.5%. A big driver of performance will be the ongoing recovery of our domestic financial and industrial businesses.
As a pure domestic equity fund, the question remains, ‘Does this economic recovery have legs?’ Firstrand’s forecast for GDP recovery does not see us, in absolute terms, getting back to pre-Covid GDP levels before 2024/5. This will be an unexciting environment for domestic financial and industrial stocks. The question remains whether the commodity boom can spill over to drive a broader economic recovery. This also impacts employment numbers, which will drive consumer activity in South Africa. The Fund has a 12% stake in Naspers/Prosus, 6% in British American Tobacco & Reinet, 22% in SA niche financials, 15% in platinum shares, 19% in domestic consumer stocks, 19% in domestic industrials and 2% in cash. We need an ongoing economic recovery in order to drive the Entrepreneur Fund’s performance going forward.