Mr Market is a moody old man. We like moody old men (perhaps its because we have a few in our office…) and we like volatile markets.
After being very patient for many years, Mr Market started to let off some steam from the beginning of the year causing some burnt behinds and red faces in his wake…
Up to the end of 2017 we saw the best global synchronised growth in 20 years. This was great for wealth creation, but this trend also holds many risks and problems namely;
- It leads to a state of euphoria where confidence levels rise to the point where people think negative returns are a thing of the past and that the market will continue to grow infinitum.
- The investment frenzy that follows strong performance ever so often pushes markets beyond the point of fair value and investments are made irrationally based on past performance.
- Fundamental investment principles are ignored while investors are seduced by Miss Greed (I refer to her as Miss because Mrs would imply infidelity…)
- The raised prices cause pockets of bubbles that will burst at some point. The longer the frenzy continues, the larger the bubble, the bigger the “POP”!
The South African market (JSE) saw its first negative quarter since 2011. The market retracted by -6,6% from 1 January to 30 March 2018.
Many investors raised their concerns about the new-found volatility at the start of 2018. In the investment world volatility is our friend and we should be thankful for the pull-back experienced so far this year. This may just have saved our bacon by bringing many investors back to reality. A 10% + global retraction like we have experienced so far this year is not considered a meaningful correction, merely a “blip” on the radar. If this continues at 10% per month for a couple of months, it can be considered a meaningful correction. Hopefully the retraction will be gradual and within reason and not a “panic sell” leading to a sudden reduction of 30% + like we have experienced many times in the past. Analysts believe that 2018 will provide positive returns but that 2019 may provide challenges that may just lead to some nasty shocks…but we also know that analysts do not have a very good track record when it comes to forecasting future market movements.
With the US market (tech in particular) and investor confidence at an all-time high while earnings of companies are coming under pressure reminds of 2001 when investors had the attitude that tech stocks could be bought at any price and that the sky was the limit. Well…the skies turned black and visions of Pearl Harbour come to mind when all hell broke loose with nowhere to hide…
I am by no means implying that the current US market resembles what led to the 2001 tech bubble and subsequent crash that paved the way for an almost 10-year bear market in the USA. But, if the irrational investor behaviour continuous it may well end up in another stock market crisis.
The fund managers we employ select shares based on their valuations. When markets are fully priced it becomes very difficult to find quality stocks at a fair price. When markets retract like they did during the first quarter, some shares drop in value to the point where their prices become attractive again.
The downside is that all of us experience negative returns in our portfolios during market corrections. As human beings we do not like losing and negative returns causes us pain in uncomfortable places.
What we must however understand is that if fund managers keep on buying assets at high prices, the long-term returns will be supressed and somewhat disappointing. To achieve superior returns, assets must be bought at below par value and assets can only be bought at these levels when markets re-price. When markets correct, a fear frenzy starts, and people start selling shares irrationally. This causes volatility and we love it. This however, may continue for some time creating a period (or many periods) of discomfort for investors. Long term investors will be used to this since this is one of the main characteristics of investing.
As we stated many times before, what we experienced at the beginning of 2018 was not losing money, it is volatility and very much part of investing. The only time you would have lost money is if you invested at the beginning of December 2017 and dis-invested at the end of January 2018. If you were invested from January 2017 and longer, your investment returns would still be positive in the currency of the investment at the end of March 2018. However, the shenanigans of the rand would have provided negative rand returns on offshore investments. The often much hated rand has become the best performing currency against the US Dollar since Presidents Ramaphosa’s election.
On that note…as South Africans we generally want a strong rand. But, is that necessarily a good thing?
The pros of a rand increasing in value are:
- Imported goods will be cheaper leading to
- Lower inflation leading to
- Possible lower interest rates (good for consumers, bad for investors)
- Offshore investors will be attracted to SA investments if the currency remains stable (not necessary stronger)
- Investments in SA Inc companies will perform well
- Once the rand has reached a point of over value, offshore investments become more attractive.
The cons of a strong rand are:
- Investments in offshore investments will provide lower returns (in rand) if the original investment was made at higher exchange rate (more rand to the dollar)
- Investments in the JSE in general will provide lower returns (65% + of total returns on JSE are from offshore)
- SA will be uncompetitive as an exporter hampering our export industry
- It will be more expensive for foreigners to visit SA
- Growth (GDP) can be hampered if the rand trades above fair value levels for too long
Considering the above we need a fair value of the Rand. Neither too low valuation or too high valuation is good.
We must often convince investors to stay put with their rand and not move offshore when the rand has depreciated aggressively. Contrary to that, investors are hesitant to take money offshore when the rand is strong. What is it with people? Why do we invest when markets are high and sell out when they are low, and why do we believe that the rand is a one-way street into dooms town when it depreciates and that it is going to become the trading currency of the world when it appreciates?
Funny creatures us homo sapiens…we always do the opposite to what is right. I think this starts in childhood. Tell a child not to do something and see what happens…
It was not just the US stock market that caused ripples across the globe that ultimately affected us as well. Year to date the SA market also experienced some serious volatility and pull back in the property sector. If we look at the divergence by mid-March between the best performing property share (Balwin Properties @ +19.8%) and the worst performing property share (Fortress REIT @ – 64.1%) we see a differential of more than 80% between the 2 property stocks! Have a look at the diagram below and see the divergence between the winners and losers.
Listed property winners
Movement year to date
|Percentage return||Listed property losers
Movement year to date
|Balwin Properties||19.8%||Fortress REIT||(64.1%)|
|Emira Property Fund||18.9%||Resilient REIT||(56.1%)|
|Indluplace Properties||17.3%||Greenbay Properties||(45.1%)|
|Arrowhead Properties||14.0%||MAS Real Estate||(20.7%)|
|Rebosis Property Fund||12.1%||Acsion||(17.7%)|
|Growthpoint Properties||10.5%||Intu Properties||(17.0%)|
|Redefine Properties||8.9%||Capital & Counties||(15.7%)|
The property sector has declined by more than 20% year to date.
The Viceroy report which questioned the Resilient Group (made up of Resilient, NEPI, Fortress and Green Bay) clearly was the main driver of the havoc caused since January. The other properties on the “Loser” list are all rand hedge stocks that were negatively impacted by the stronger rand as well as some other concerns. Hedge Funds caused havoc by shorting property stocks and this can continue while these managers think there is more “profit” to be made. Most of the stocks should recover to a certain extent however, the Resilient group of companies’ pullbacks in value may be more permanent after they were caught out “massaging” the group’s share price through cross holdings and re-directing capital to a trust that in return bought the group’s shares again. The impact of the group’s reduction in value is severe since it represents 42% of the global counters within the SAPY Index.
It is encouraging that our property fund of choice, Nedgroup Property Fund, has provided a return of almost 4% year to date against the sector return of (-) 20%. The fund manager avoided the major global companies and what worked against the fund during 2017, has resulted in them being the best performing property fund year to date in 2018. Well done to Ian and his team!
For the hard-core property bulls that believe property cannot retract, this a reality check. Property shares can be as volatile as general equity shares. This correction brought property funds closer to a realistic fair value and has created some buying opportunities for fund managers. It is also notable from the above graph that most of the “losers” are global funds that would have suffered because of the rand strengthening but not to the extent of their actual pull-back percentages. Notably, the SA property sector is now also represented by more than 40% global property REITS and shares by market capitalisation. This will automatically result in higher levels of volatility due to currency fluctuations, something we did not have to seriously consider 3 years ago that we will have to contend with going forward.
The above just once again points to the importance of diversification. Over exposure to a single asset class or a single asset is very risky.
Then lastly, I would like to touch on the budget that was delivered in February. The main areas where our clients will be affected are as follows:
- Increase of 1% in VAT (negative impact for all)
- Change to Regulation 28 increasing offshore limits in investments regulated under the Pension Funds Act from 25% to 30% (positive for all)
- Increasing the offshore limits of investment companies from 35% to 40% (positive for all)
- Increase of 52 cents per litre in fuel levy (negative for all)
- Increase of estate duty to 25% on estates above R 30 million (negative for wealthy)
- Sin taxes (negative to all party animals, (all of us?))
Hopefully the newfound optimism in SA will lead to better returns in our SA market. Even though our market provided a return of 9,6% over the past 12 months (at the end of December the return was 17.4% over the previous 12 months) we still only experienced an annualised return of 6.1% per annum over the past 3 years. This is very disappointing if we look around us and see what markets globally have done. Of bigger concern is the fact that of the 6.1% annualised return achieved, 3% was from Naspers. Without Naspers our market would truly be in the doldrums. The fact that one share has such a profound impact on a total market should scare all of us…
The best news, apart from a new president, was the Moody’s rating. The fact that their outlook on SA has changed from negative to stable has numerous benefits which also led Treasury to reduce their weekly auction of Bonds from R 3.8 Billion to R 2.4 Billion for the following reasons:
- Better growth prospects for SA
- Stronger rand
- Lower borrowing costs
- Government debt is likely to peak sooner and will be less than expected
Hopefully these promising signs and the general positive outlook for SA will provide South Africans with the “feel good” feeling again. Something all South Africans need.
Now our new beloved president must just come clean and explain exactly how the land expropriation plan is going to be handled.
And then will someone please give Julius a klap (I almost said a snotklap…)
Stay safe and remain invested. Trying to time the market is not a strategy, it is a guaranteed way to miss your long-term investment goal.