A tale of two markets
Over the past quarter, many investors have been scratching their heads at the resurgence of the S&P 500, the JSE and other market indicators since the dramatic selloff just three months ago. This rally can largely be explained by near-zero interest rates provided by central banks, and by the significant fiscal stimulus supplied by governments in response to the Covid-19 pandemic.
The local market skyrocketed 26% over the past three months, the biggest quarterly movement in almost two decades, taking the JSE to just 6% below where it started the year. However, this should be viewed against an undervalued rand, coupled with a dramatic rebound in commodity prices over the past quarter, and “the Naspers effect”, all of which act to mask the dire struggle of domestic-facing JSE-listed companies.
Local: domestic focussed vs global focussed companies
Delving into the numbers, it becomes apparent that there is a disconnect between the resurgence in the share prices of South African-listed companies with global exposure, and that of domestic-focussed local listed companies. This is evident from the Domestic Swix40 declining by 29.4%, whereas the global portion of the SWIX is up by 21.4% .
The South African economy faces significant headwinds, including a rapid rise in unemployment, a significant decline in tax revenue collection and an anticipated 10% GDP contraction. It should come as no surprise then that domestic-focussed companies did not partake in this quarter’s rebound.
The reality is that South Africa was in a weak economic position going into this pandemic and, in the absence of structural reforms, the economy will come out even weaker. In such an environment, cash preservation is a key priority. Rights issues have been a feature of the past six weeks as JSE-listed corporates have looked to shore up their balance sheets. In the depressed economic setting, dividends have also been put on hold to the extent that the aggregate index pay-out ratio has dropped to a 10-year low and, for the first time since 2004, the South African pay-out ratio (38%) is below that of MSCI EM (42%).
At an industry level, the past quarter’s results were positive. While South African real estate bounced +20.4%, it remains down 37.6% year to date. The precarious position of commercial real estate (with businesses across sectors under pressure) and residential real estate (with incomes and employment prospects under stress) leaves this asset class with much uncertainty in the short term. Similarly, the fall in foot traffic through malls has hit retailers, and stressed consumer spending can be expected to be a material factor dragging performance in the sector down for the foreseeable future.
Resource shares and equities were largely responsible for the uptick on the JSE. The gold price soared to its highest levels in eight years as nervous investors seek “safe haven” assets. The resource sector returned 40.6% in the second quarter, well ahead of Industrials (+16.7%) and Financials (+7.0%).
The outlook for South African equities remains weak. However, while earnings expectations are depressed, a lot of the bad news is already factored into the price. On a two-year forward price-earnings multiple, South Africa appears relatively cheap, whereas this ratio is fairly close to all-time highs for the United States (US).
Source: RMB Morgan Stanley Research
Global: half full, or half empty?
Over the past three months, the S&P 500 index in the US saw its largest quarterly gain since 1998. To put recent volatility in perspective, the first quarter saw the fastest 30% global equity drawdown in history, while the second quarter saw the largest 50-day advance in market history.
Some commentators point to a complete detachment between markets and fundamentals. Others are optimistic that significant levels of fiscal stimulus, combined with sustained low inflation and low interest rates, create a supportive environment for risky assets to outperform. Consider, for instance, that low bond yields are encouraging investors into riskier assets (such as equities) in search of returns, and there is a case to be made here.
Diversification in the world of investing has never been more important than it is right now. Betting big on a single asset class, company or idea could produce large upside but also presents material risk. We don’t regard this type of behaviour as investing – this belongs in the bucket of speculation. With central banks and governments in “whatever it takes” mode, over the short term, global equities look set to sustain their outperformance over bonds. However, over the long term, fundamentals will steer the direction of the market. In this environment, forecasting has never been a foolhardier errand. Our emphasis remains on buying good assets at good prices in all environments, and across portfolios we are sitting with above-average cash holdings that gives us optionality and opportunity.