Investment Environment November 2015


At the end of the last quarter (August) equity market conditions were looking very bleak, however equities bounced back in September and October but in November equities were marginally down. At the end of August we encouraged Investors to be patient on the basis that equity markets in general follow a bull trend notwithstanding the interim bear markets that are sent to test equity Investors’ resolve. At the same time we indicated that we believed an increase in interest rates by the Fed would be a flag that should ultimately be positive for equity markets. The basis of this argument was that the Fed would only increase interest rates if it believed the underlying US economic factors were strong enough to justify this. Fed Chairperson, Janet Yellen, has said that the US economy has “recovered substantially” and she signalled that interest rates will be increased on the 16th December. This will be the end of an era of expansionary monetary policy followed by the US since the global financial crisis of 2007/8. Arguably “normalisation” of interest rates will create more financial stability.

The concomitant effects have been a strong USD and weak commodity prices. Although the USD reflects badly on commodity prices, in any currency they have been weak. and The gold price is at a 5 year low, platinum price at a 7 year low as is the copper price etc, and the price of oil (Brent Crude) is down 62% since the 2014 high. This, while sounding dismal for a resource based economy like South Africa, is in fact positive for US equities. The exception would be low oil prices because of the loss of US jobs. A major driver going into 2016 will be the American consumer who will be better off than he has been in the last decade. Some of the factors benefitting that consumer are the petrol price is down 44% in the last year, wages have accelerated and there is virtually no inflation at 0.2% year on year.  Anecdotally, this scenario can be supported by December being historically a good month and interestingly with the US elections in 2016, 17 of the 19 elections since World War 2 have produced positive returns for the S&P500 Index.

The flip side of the positive news above is a weak ZAR/USD which we hope is in the price as we know that foreign investors exited R19.3 bn of equities in November but this was countered with the purchase of R 19.9 bn of SA bonds. The exit from equities can be largely explained by the selling of SAB Miller as Investors take profits on the expected take over and the dumping of mining stocks as evidenced by their poor share price performance. A further blow to the ZAR would be if the rating agencies downgraded South Africa’s outlook from stable to negative. It is expected that Fitch will downgrade SA to the same level as the S&P (BBB-) which is the lowest Investment Grade. It would be a negative surprise if the S&P also downgraded SA bonds below the Investment Grade and would result in index tracking bond funds being forced to sell SA positions. This in turn would put pressure on the ZAR.

While all this has been going on it is important to remember that there has been some sanctuary on the JSE in the Financial and Industrial index (FNDI) as shown in the graph. 

If the index is viewed at the All Share (ALSI) level, the performance of the financial and industrial counters is outweighed by the negative effect of the resource stocks. The FNDI alone shows how portfolios with limited resource exposure have performed (most of DI’s portfolios are predominantly in this position). However the index is trading on an expensive PE of 21.4 x earnings, which is stretched, but can be justified by the low interest, passive inflation environment and real growth in earnings of these companies. The major counters of the FNDI are Naspers (13.9%), SAB (13.4%), Richemont (8.5%) and BAT / Reinet (4%). To achieve a reasonable performance a portfolio had to have these counters in and with the expectation of the ZAR remaining weak for longer the same should be true going forward. DI continues to concentrate portfolios on companies which have strong ZAR hedge qualities due to significant offshore operations.

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