To the end of September this year, just six companies in the FTSE/JSE Top 40 had made any gains in 2018. Five of those are resource counters, responding to a single theme. The sixth is Investec, which has gone up on the back of the announcement that it will be unbundling its asset management business.
Overall, that makes for a pretty dismal market, and it doesn’t get any better if one looks more broadly. According to analysis by Denker Capital, almost 40% of stocks in the FTSE/JSE All Share Index (Alsi) are currently trading at prices below where they were five years ago.
If you adjust for inflation, that number goes up to over 60%. In other words, nearly two-thirds of the market has gone backwards in the last five years.
“There’s no doubt that the cumulative effect of the Zuma years on the economy is being felt in asset prices,” says Denker Capital’s Ricco Friedrich, manager of the SIM Value Fund. “There was a bit of a reprieve in January and February, but in hindsight it’s easy to see that the market ran away from itself and those valuations were not justified at the time.”
Friedrich points out that since February the Alsi has sold off over 30% in US dollar terms, and this persistent poor performance has now become the most dominant theme in investment discussions. As 27four Investment Managers stated in a recent note:
“This ultra-low return environment … coupled with a combination of domestic factors and the increased regulatory allowance for offshore investments, has provided the perfect storm for local investors to become increasingly – and perhaps excessively – exuberant in allocations to offshore asset classes.”
Doom and gloom
Many people seem to have given up on the JSE. This has only been emphasised by the weakness in the South African economy and local uncertainty created by issues like expropriation of land without compensation. Listed companies have been struggling to produce decent results.
“You add all of those factors together and you end up with a market where it is now,” says Delphine Govender, chief investment officer at Perpetua Investment Managers. “Any space I’ve been in lately, investors are incredibly bearish. There is so much doom and gloom that everybody is trying to work out if they should be emigrating, or, if not, how much of their money should be emigrating.”
However, in a scenario where the consensus is that the local market has no prospects, contrarian investors see something entirely different.
“We have this double whammy of a tough economy on the back of the lost decade, coupled with a very aggressive emerging market sell-off, and the result is very cheap shares on the JSE,” says Shaun le Roux, the manager of the PSG Equity Fund. “What we are seeing is a broad swathe of stocks that are trading at bear market valuations on earnings levels that have been struck in very tough economic conditions. We conclude that even if economic conditions stay tough, shareholder returns from a lot of these neglected stocks will be good.”
As Govender points out, given how much prices have come down, there is more value across the market than she has seen for over half a decade.
“The projected return on our portfolio is the highest today it has been at any point in the last six years,” she says. “And this is a fundamentally-driven return, coming from dividends and earnings.”
That doesn’t mean that she’s calling the bottom of the market. On the contrary, she believes it is possible that prices could still go lower. However, there is a huge amount of bad news that is now priced in.
“Market prices now are discounting very low road scenarios for what the economy has to deliver for these companies to do well,” Govender argues. “All you need is for the reality to be less bad than what is being priced in. You don’t have to price in a high road.”
Le Roux agrees: “Essentially we are getting the option that the SA economy grows for free,” he points out. “If it were to grow, we would expect returns to be very good, given that some companies are showing double-digit free cash flow yields, which are fairly rare in the South African context. And those are cash flows that have been made in tough times.”
Time to be greedy
As Govender notes, some of the companies that are now attractively priced would have been considered high-quality investment options fairly recently.
“If I had built a portfolio of Woolworths, Tiger Brands, Aspen, and Mediclinic three years ago, you would have said that’s a great quality portfolio,” she says. “Now their share prices have more than halved and those shares have become deep value.”
While Friedrich agrees that there may be opportunities for stock pickers on the JSE, he is more cautious about being too optimistic about the overall market.
“If I look at the forward price-to-earnings multiple, we are at the lowest levels since 2012,” he says. “But when I look at the earnings growth numbers factored in, I would argue that the market is being way too optimistic.”
While it is not his core view that there will be a big market sell-off, it remains possible given numerous risks in the global environment such as high valuations in the US, rising global interest rates and the trade tensions between the US and China.
“One has to bear in mind that valuations could easily fall another 30% and ask the question, what are the circumstances that could contribute to that kind of de-rating,” Friedrich argues. “There is no shortage of things that could contribute to that.”
For Le Roux, however, the time to be greedy is “while confidence is so poor and everyone is so fearful”.
“To me, it does feel quite similar to the early 2000s, where we had been through a rand crisis – people had given up on local equities, and assumed that the economy was going to be in the doldrums forever,” he says. “The climate right now doesn’t feel completely dissimilar.”
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