Investment Environment July 2018

31.07.18

International

The international, and more particularly the US, is potentially a happy story, albeit that equities have been flat for 2018.

The US economy produced a 4% GDP growth for 2Q2018 which is indicative that Trump’s policy of America First seems to be working, but the rhetoric around trade war remains an overhang for risk markets such as equities. It is important to note that as the US economy continues to show good growth, which is translating into strong corporate earnings, the equity markets are getting cheaper all the time. This is caused by the denominator (earnings) increasing and the numerator (price) remaining stable - valuations (P/E’s) become less demanding.

If you look at the graph below, which is the S&P500 (being the equity index for the US), you will see that after the February down the market has trended gently up. In our opinion the February down, while driven by interest rate jitters, was more about companies being overvalued on the back of a very strong 2017 which showed great price appreciation.

As we state in the paragraph above, while the market has been in pause mode for the first half of 2018, it looks like these valuations are becoming more attractive as each set of results is released hence the mildly positive trend. This is backed by Trump’s tax legislation providing a strong underpin for corporate earning and the assumption that the same man, Trump, doesn’t drag the world into an unnecessary and unproductive trade war.

The other potential headwind is interest rates which have been “zero” since the GFC of 2007. Such a period has never been experienced as shown in the graph, and although interest rates are moving off the zero base they do remain benign.

South Africa

2018 has been a very lack lustre year with the JSE moving sideways to down. The reason for this is South African equities are in a stale mate with poor economic fundamentals and a great deal of political uncertainty. SA GDP has fluctuated wildly in the last year and for 1Q18 declined 2.2% quarter on quarter. This knocked confidence particularly business but is also a reflection of consumer confidence. With the US and China threatening a trade (tariff) war emerging markets are impacted as commodity prices retrace.

SA is at a crossroads and what is needed to exit this malaise is leadership. Having had the benefit of the Cyril spring it is now critical that Ramaphosa is able to unite the ANC and achieve a successful election entrenching his leadership in 2019. Political analysts point out Ramaphosa’s test will be the land issue and successfully navigating that on ANC terms (which are apparently not onerous to land owners) to become policy for a united ANC election manifesto. Unfortunately, the predictions if this fails are dire.

Like the politics it would appear the equity market is also at a crossroad with many large capitalization stocks on relatively cheap valuations ratings and good dividend yields but this will only change if we see good leadership (political and business) translating into economic and earnings growth. The graph below reflects the growing uncertainty!

It appears all bad news at the moment, but one has to believe in equities and vasbyt as the companies continue to show good results even in the face of difficult times. We have also continued to remain ZAR hedge investors which means the weaker ZAR should help share prices. Again, with the prevailing uncertainty this will take time to come through. As a bit of diversification we have also introduced a few “pure South African” companies that we believe are solid. These include Italtile, KAP and more recently Libstar which is a FMCG producer for retailers’ own brands. We believe Libstar is cheap and consumers will migrate to own brands as they feel pressure.

So an optimistic view would be better politics that allows companies to unlock their cash hoard, translating into substantial growth. Optimistic – but here’s hoping!

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