Home Articles Special Report – Investment Themes: For equities in 2014

Special Report – Investment Themes: For equities in 2014


If you’re looking to invest some new capital in the markets during early 2014, you are facing some tough choices. Analysts vary as to their opinions, but the consensus seems to be that local markets are already expensive in the wake of a four-year bull market and hold considerable downside risks, while the value of the rand (R11 for 1 US dollar) means that if you haven’t already taken your full allowance offshore, there is also the downside risk of the rand recovering substantially from this position – and denting the rand value of your portfolio.


Mike Lledo CA(SA), CEO of financial advisers Consolidated, explains that in respect of capital already invested the best advice is, “Don’t panic, and don’t make any precipitate decisions.” This advice is echoed by private investor Marco Visentin who, along with a financial adviser, manages a portfolio that has grown over the years (through a policy of simply buying and holding) to R4,5 million.

Lledo says: “I see some clients that are beginning to panic at the rand’s performance. Just as in 1999–2001 they believe the rand is about to blow out and they want to get their money out of the country. In fact, many astute investors are bringing money back into the country at this price.

“The important thing to remember is that even the best experts have no real idea where the market or currency is going to go and understand the futility of trying to time the market. All anyone can say is that over the long term equities have delivered real returns of 8% a year. Investors invariably earn far less than that – because they try to time the market and make the mistake of panic selling.”

He gives the example that the S&P Index over the last 20 years has delivered an annual return of 12%, while US investors earned only 4% on average. The comparable figures in South Africa are 18% on the Johannesburg Stock Exchange but 8% for actual investors.

“This demonstrates that the worst thing an investor can do is to not stick to his financial plan,” says Lledo.

Visentin, an engineer in the mining sector, explains his philosophy: “I take a long-term investment horizon of five to ten years. I rarely sell but reinvest all the gains including dividends back into the portfolio. I handle the volatility of the market by buying into good companies whenever they demonstrate value, and having the patience to know the shares will recover, if they fall.

“I manage two portfolios entirely invested in equities, except one has a 25% holding of cash in terms of its mandate. In the portfolios we are heavily weighted towards the mining sector (12%), with Lonmin, Impala Platinum, BHP Billiton, ZCI and Anglo American. In addition, I believe all portfolios ought to have the five ‘Rs’: Richemont, Remgro, Reinet, RMI and RMB Holdings.

“I also favour media (11%): Caxtons and Times Media, with the over-the-counter traded Element One (which is associated with Caxtons). In industrials I have SABMiller, KAP Industries; financial services: Liberty; telecoms; Telkom; and property companies African Overseas and Marshall Monteagle. I also have shares in UK shopping complex manager Tradehold.”

Chris Freund, Head of SA Multi-Asset at Investec Asset Management, says: “There are three factors that drive equity markets: valuation, the economic cycle and the extent of liquidity. Even though valuations are relatively demanding, this should not put a dampener on South Africa’s equity market returns over 2014. It’s only when valuations are at extremes, very expensive or very cheap, that they are likely to drive returns.

“The economic cycle is broadly supportive of equity markets in 2014. Currently the liquidity accelerator is very supportive of equity markets, but this could change with the Fed’s tapering plans. We believe the new Fed chairman, Janet Yellen, will take a nuanced approach to US unemployment and labour issues. We don’t believe there are going to be any overly aggressive moves on the monetary policy front in 2014,” says Freund.

“Our portfolios are fairly long equities. Tactically, equities could suffer a quarter where they could have a pullback. Equities have virtually gone up in a straight line for a while now, so it would be no surprise if there’s a period of consolidation.

“On a medium-term horizon, we take a long position on equities and are comfortable with the volatility that comes with maintaining this exposure. Our portfolios are fairly neutral between bonds and cash at this stage.

“Within equities, we have a preference for the life insurance sector because we expect these companies to regain market share in the savings industry. We still like some of the bigger banks. FirstRand remains our preferred player in the South African banking sector. Many of our large industrials are global companies, such as British American Tobacco (BAT), SABMiller and Richemont. These companies can’t be considered cheap anymore, having done very well over the last few years.”

Marius Fenwick, Chief Operating Officer at Mazars, outlines some broad investment principles that investors should consider if developing an investment strategy for the first time.

“First, there are no guarantees that particular stocks you pick are going to be winners. In general one would expect that blue chip shares should provide satisfactory returns over long periods. Second, one must accept that the different sectors of the stock market perform differently during the different economic and interest rate cycles.

“This brings us to the most important factor – buying stocks at the right price. Irrespective of the share you buy, if you pay too much it is going to disappoint and it will take much longer to provide you meaningful returns. Having said that, one must evaluate why the stock is cheap on the day of purchase and what the chances are for it to provide satisfactory returns. A good example is platinum and gold shares at the moment. It is generally accepted that these two classes of shares are great value at the moment. But given the world economy and labour issues in the mines it may not be the ideal stocks to own today, although the upside is huge if these issues can be sorted out,” says Fenwick.

As to where to invest for the future, he says that Africa is the hottest topic at the moment. “Growth opportunities are expected to be huge over the next ten to twenty years. One can obtain exposure to Africa via the JSE, which is considered to be one of the best exchanges in the world. Many JSE-listed stocks have a strong presence in Africa.”


Just how expensive is the JSE? Seema Dala CA(SA), who looks after Allan Gray’s offshore partner Orbis’ client servicing in South Africa, points to the JSE’s long-term average multiple (P/E) of 12 times and says the current multiple of 18 makes it expensive, especially at a time when corporate profits appear unsustainably high. A higher than normal multiple on a higher than normal earnings base means that if either or both return to their average, domestic equity prices could fall dramatically.

South African fundamentals are also deteriorating. Dala explains that high multiples are due in part to several years of quantitative easing in the US and elsewhere which flowed to South Africa and other emerging markets but which flows are now starting to reverse. It is this, coupled with the poor fundamentals and uncertainty regarding unrest in the South African economy, which is driving the current weakness of the rand.

This exposes the weakness of the South African economy. “We have twin deficits which have been plugged by capital inflows. It is only our status as a commodity-exporting country that has enabled us to keep things together at all – and now commodity prices are also weakening,” she says.

There are pockets of value still to be found on the domestic market. Allan Gray favours holding high-quality, defensive, well-capitalised companies which are typically also rand-hedge counters, such as BAT, SABMiller and Remgro. Dala recommends that if investors are buying domestic companies they choose ones with a high proportion of global earnings that are able to withstand any potential downturn.

“The rising interest rate cycle will place South Africa’s hard-pressed consumer under even greater stress. We expected this to happen and have consequently had low exposure to the retail sector over the past two years,” says Dala.

Fenwick adds: “The South African market currently is not ideal. Stocks are expensive, although there are pockets of good value. Our geopolitical situation is not ideal and our budget and trade deficits are on the wrong side of the scale. These factors lead to offshore investors getting the jitters and they would rather invest in developed markets that seem to have turned and starting to show promise. This will lead to an outflow of foreign capital and ultimately continuous rand weakness and depreciation.”


Ben Kodisang CA(SA), and Managing Director of Stanlib Asset Management, says that offshore investments are the preferred asset class at the moment. “It is a good time to be invested in US equities due to the upside of yields increasing with the economy. However, I would not recommend offshore markets for new money – if you’re not already at full allowance offshore you’ve probably missed the boat. It has been a terrific place to be for the past two years.”

However, there are also pockets of value even at an exchange rate of R11,20 to the dollar, he says. “Emerging markets have been over-sold in the rush to developed markets. The current valuations differential doesn’t make sense. We have a positive view on emerging markets, and particularly Africa,” says Kodisang.

He recommends investors buy into a global balanced portfolio or global pure equity fund. “Because of the risks, there are important decisions that have to be made and for this reason you want an active decision-making strategy. For someone managing their own global portfolio I would currently recommend being neutral offshore because of the rand’s weakness.

“Our preferences among developed markets are for the US and Japan, and among emerging markets we favour Africa, equities rather than credit or bonds. In 2013, Africa was the single best performing asset class at Stanlib. The investment case for Africa is one of demographics. It has strong long-term fundamentals as resources-led export-based economies. We see increasing collaboration between Africa’s regions and countries and the opening up of the skies to ease trade between each other. In fact, Africa is contributing an increasing proportion of South Africa’s own GDP growth,” he explains.

Fenwick adds: “Currently, offshore equities are the asset class of choice. In particular largely debt-free North American companies are in a perfect position to take advantage of a recovering America and Europe and ultimately a recovering world. They are a lot leaner that they were pre-2008.”


Warren Buhai CA(SA) and resources analyst at Stanlib, recommends that notwithstanding some concerns, now is probably the right moment in the global economic cycle to be considering accumulating resources stocks.

“Global economic growth is set to increase, which is usually when resources are attractive. However, there are some challenges: commodity prices are already quite high with not much scope for increase, and there are concerns as to the strength of the Chinese recovery.

“We believe that commodity prices should hold up for the next two to three years, and to avoid internal social unrest the Chinese government has to continue pumping money into its infrastructure for at least three to five and possibly even ten years. However, the variables are if either of these two does not happen,” says Buhai.

In fact, no matter what happens with these two imponderables, there are two local stocks offering value at the moment, he says: Sasol and BHP Billiton.

“These are our preferences as both have oil, while BHP has both a good mix of assets and exceptional management. Sasol has diversified through new projects in North America and so internationalised its business.”

In terms of precious metals, he explains that gold mines are not as profitable as many people think, given the low gold price compared to costs.

“Platinum is also currently struggling at the current rand-US dollar price, and the issue here is whether platinum demand will pick up as the EU and Chinese economies pick up. There has been an oversupply position for some time, but current supply constraints are starting to bring that into balance and potentially eventual undersupply. Therefore, we’re positive on platinum and palladium – but only if prices increase. Impala Platinum has the best intrinsic value at the moment,” says Buhai.

“Against other sectors, the resources sector looks interesting as a value sector because others have increased so much.”

However, Allan Gray says that notwithstanding this, the firm remains underweight in the resources sector and would prefer to be even more underweight. Dala says the fundamentals of South African mines – such as labour issues – have so fundamentally changed as to have created a negative cyclical trend, which is reinforced by the risk of falling demand from the Chinese economy.

“However, we are quite positive on the metals themselves – it is better to hold the metals directly in ETFs than to hold mining companies,” she says.

Freund adds: “We [Investec] are relatively underweight in the broad commodity complex, mainly because of concerns about China’s growth and the demand-supply dynamics of key commodities such as iron ore and copper.”


Visentin believes that one vital aspect of success in investing is to educate yourself – even if you use a fund manager or investment adviser.

“I am self-taught and have developed my strategy by listening to my portfolio manager and reading financial newspapers, magazines and asking lots of questions. The investment philosophy that I have developed is to buy bricks-and-mortar companies that have historically performed very well through various economic cycles, are cash flush, have a strong cash flow, have healthy debt-to-equity ratios, have a good internal rate of return and strong management, and pay healthy dividends depending on the type of shares one has invested in.

He explains that ‘corporate actions’ and dividends amount to as much as 40% of his return on investment and are not to be ignored. “One needs to be very patient and not panic, and that is why long-term investment is a must, even in trying economic times. My portfolios have survived the financial crisis since 2008 and have even performed better during these periods.

“My objective when investing is to better the rate of CPI by 15%, and because the companies I have selected most pay healthy dividends, I have achieved over the past decade a return of 35% and better.”


Johan Strydom, a Sanlam Private Investments portfolio manager, lists some of the major risks to investment markets for 2014.


•         Markets will be focusing on the timing of the tapering of quantitative easing as 2014 progresses, leading to potential market volatility. This may have a negative effect on the currencies of emerging markets, including the rand, as foreign investors pull out.

•         The sustainability of Chinese economic growth. China has become one of the premier drivers of global economic growth but has its own headwinds in the form of non-performing loans in the Chinese financial system, as well as appreciation of its currency, the renminbi. In particular, commodity prices will be dependent on the performance of this powerhouse.

•         The sustainability of the recovery in the EU and especially Japan will be important in supporting global growth rates.

•         Globally, valuations are a little stretched, which makes it crucial that the expected earnings growth does materialise.


•         Valuations: Our valuations are high against their historical level, against other emerging markets, and against other global markets. Therefore we may see a consolidation in our market as we wait for earning to come through.

•         Tapering: The South African market will also be subject to how the Fed’s tapering plan unfolds and this will add to volatility in our market and to the value of the rand.

•         Interest rates: The question is not the recent 0,5% hike but whether this represents the beginning of a rising cycle that could ultimately be as much as 2 percentage points, placing the consumer under stress.

•         A weaker rand: This has a potentially significant impact on inflation and a detrimental effect on the consumer. Companies with large exposure to the local consumer, such as retailers, may well find trading conditions extremely difficult. ❐

Author: Eamonn Ryan.