Even though market analysts are reflecting on an abundance of value on the SA stock exchange, there is a growing contention that the best place to be for the next few months is the sidelines.
RECM & Calibre CEO Piet Viljoen contends it’s a healthy point of departure to realise that nobody knows what is going to happen on the JSE in the months ahead.
"The economy is tough … but that’s when share prices are low. The only way to manage risk is not to pay a high price for any asset."
Local investors, though, are reeling — some experiencing the sharp claws of a bear market for the first time. It will take some convincing that this is a buyers’ market.
But Viljoen reminds: "Prices only get lower when investors are despondent. You have to force yourself to invest in a contrary fashion to your emotions."
This view is echoed by Hosken Consolidated Investments (HCI) CEO Johnny Copelyn, arguably one of the best investors on the JSE over the past two decades.
Addressing shareholders at an AGM this week, Copelyn seemed to relish the market turmoil. "One has to accept that SA has gone through an unbelievably bad time. There is still nervousness … but HCI made its fortunes by trading on adverse sentiment."
He stressed that HCI is in the business of being countercyclical. "We see opportunities in SA, and have a very positive view of the country for the long term." Other investors might not be able to muster the same stoicism, with the scoreboard making for depressing reading.
Near the end of January — when Ramaphoria was still buoying investment sentiment — the JSE’s all share index (Alsi) appeared to be heading for 62,000 points. This week it had ebbed to around 51,000 points.
The "comedown" has been startling, and the ride for investors extremely bumpy. Since the end of January, a graph of the Alsi will show half a dozen "plunge and spike" patterns before establishing a longer drop with only the odd upward bounce.
Since the FM’s cover story on picking recession-proof stocks in mid-September, the Alsi has given up another 10%. On a year-on-year basis the Alsi is down around 7%. But from the peak 12-month level, this key market gauge has shed around 16%.
That’s the kind of paper loss that should rattle anyone with a pension fund — especially those getting closer to retirement.
It is extremely difficult for investors to hold their nerve in such a market — even with an increased volume of placatory utterances from professional fund managers.
The biggest worry for investors is that there simply appears nowhere to find safety from the market ravages.
Reliable blue-chip stocks that have previously offered solace to investors in testing times have beaten a hasty retreat.
Pharmaceutical giant Aspen is down a gut-wrenching 42% on a year-to-date basis, while private hospitals conglomerate Mediclinic International has dropped a sickly 37% from already weak levels in 2017.
But probably the biggest damage to the portfolio values of ordinary shareholders would have been "default" stocks like technology hub Naspers (down 25% so far this year) and cellular services powerhouse MTN, which has shed over 35% of its value.
In each of the above, there are specific reasons why sentiment has weakened. But the overriding point is that bad news around strategic setbacks or perceived balance sheet vulnerabilities have induced near panic when previously investors might have contemplated these issues more circumspectly.
One explanation for these extreme reactions to underperformance or strategic setbacks is the Steinhoff International factor. The dramatic collapse in Steinhoff’s share price meant investors learnt the hard way the cost of ignoring initial signs of trouble — remember that the first hints of impropriety at the retail giant surfaced in 2015.
The perilous plunge in value of debt-laden stocks like Aveng, Basil Read and Distribution & Warehousing Network would probably have also added to increased investor wariness. These were all regarded as solid counters several years ago.
Even the popular retail sector looks less reassuring, with Woolworths, Shoprite and Pepkor appearing to take the most strain.
One might argue that those spooked by the sudden weakness in global growth stocks like Aspen, Naspers, Mediclinic and MTN could always switch to more defensive counters. Unfortunately, that avenue now also has its twists and turns, with the share prices of defensive heavyweights such as British American Tobacco (BAT) and Anheuser-Busch InBev (AB InBev) looking uncharacteristically frayed.
Brad Preston, portfolio manager at Mergence Asset Management, stresses that investors need to be careful before looking for safe havens in global JSE stocks that have traditionally been deemed defensive.
"The global sell-off has been driven by higher bond yields, and companies like AB InBev and BAT are more geared than they used to be. You might expect the complete opposite at this point of the cycle."
It could be argued that perhaps investors set too much store in the prowess of large SA companies with global reach.
But the value massacre is not restricted to the JSE.
Market darlings — or rather, former market darlings — have also been knocked about mercilessly. The share price of telecoms group Blue Label (now with a large investment in cellular services giant Cell C) has dropped 67% so far this year, while fund manager Sygnia (down 39%), private education specialist Curro Holdings (-44%), agricultural investment company Zeder (-30%), liquor group Distell (-16%), Rhodes Foods (-33%) and building supplies retailer Cashbuild (-40%) also make for painful reading.
Even companies that last year were considered to be poised for recovery have drifted further down. Here we have Coronation Fund Managers (down 37% this year), Famous Brands (-9%), HCI (-11%), PSG Group (-20%) and Brait (-15%).
Most banks and insurance counters have also come off, and the industrial sector continues to look depleted.
The shares that have, generally speaking, held out the best are the large resources counters like Anglo American, Anglo Platinum and energy giant Sasol, as well as special situations like alternative energy group Montauk and packaging group Bowler Metcalf (which realised a better-than-expected profit disposing of its share in a soft drinks business), and recovery stocks Adcorp, Adcock Ingram and Altron.
But these are few and far between — as can be seen by the surfeit of stocks weekly testing new lows versus the few that are traipsing to new highs.
The truth, as we are told often enough, is that fortunes can be made by brave punters willing to capitalise on fear and loathing on the JSE. But that’s easier said than done.
For instance, a punter reckoning sugar giant Tongaat Hulett offered sweet value at R75 at the end of September would be bitterly assessing such a decision, with the share crumbling to below R55. Perennially profitable small-cap companies that are trading on low single-digit earnings multiples simply trade lower by the week — the market seemingly sceptical of the earnings endurance.
One positive sign is that there is an increased number of delistings on the cards — Howden Africa, Torre, Verimark and Cargo Carriers. A spate of delistings — where a knowledgeable large shareholder reckons it’s worth buying the entire company — can often signal that the bottom of the market is close or that realistic market valuations have gone right out the window.
The point is that with jitters abounding, the normal valuation metrics can go out the window — sometimes helped by the kind of dire conjecture that is typically generated on the fringes (read: splashed on social media platforms) in a bear market.
Cannon Asset Managers CEO Adrian Saville advises that in a zero-growth environment and the absence of corporate earnings, some companies navigate better than others. "Companies like Combined Motor Holdings (CMH) and Afrimat both managed to hold earnings at respectable levels in respective industries that are struggling."
He says it is difficult — and naive — in the prevailing environment to be euphoric about SA. "But we have to recognise that SA has gone through a remarkable transformation in the past 12 months. We need to sort out the SOEs [state-owned enterprises] and re-establish fiscal discipline. These issues are not being ignored … they are being addressed."
Saville maintains that a modest move in economic growth will feed investment sentiment. "The robust firms — like CMH and Afrimat — will recover quickly … earnings could rocket."
Independent analyst Nigel Dunn says what is happening on the JSE is not easy for many investors to understand. "There are a host of forces at play that are making markets increasingly unstable. One can liken it to the avalanche. Just one [snow]flake will trigger it. But which flake is it to be?"
He is inclined to look abroad rather than focus purely on the domestic front. "SA will not buck a global trend, irrespective of how cheap it is."
Dunn concedes, though, that SA Inc — stocks with primarily a domestic economy focus — are looking increasingly cheap, with a number of leading businesses trading on single-digit price-to-earnings multiples.
"I think that in the third quarter SA will climb out of a technical recession … The rand is heavily oversold, and unless we stand on the cusp of a global financial crisis I would expect to see some recovery with a concomitant improvement in confidence."
Overall, though, he is cautious. "I would expect a bounce to work off some of the oversold conditions. But I am not convinced the global bull market has much more left in it, so I would use rallies to lighten up."
More optimistic is Alpha Wealth portfolio manager Keith McLachlan, who believes fortunes are going to be made by decisions on the JSE in the next few months. "The fortunes will be made now and realised in a couple of years’ time when everyone else catches on."
There simply appears nowhere to find safety from the market ravages
— What it means
This is a sentiment partially shared by PSG Asset Management CEO Anet Ahern. In correspondence to clients Ahern argues that the best investment returns are born in times of fear and uncertainty. "The prevailing fear in local markets has given rise to the opportunity to buy higher-quality stocks (particularly mid-cap industrials) and bonds at wide discounts to what we think they are worth. Similarly, unpopular and uncrowded parts of global markets present attractive prospects for investors willing to take a long-term view."
McLachlan says the short-term outlook for the JSE is clouded by political events, most notably how President Cyril Ramaphosa will keep a fragmented ANC united and walk the tightrope of the expropriation without compensation policy. "I suspect if the ANC wins the upcoming election convincingly, there will be constructive action by Ramaphosa. This might also mute the political noise on the fringes, which has clogged up the investment system."
McLachlan believes developments at SOEs could have a huge bearing on investment returns in the medium term.
"[Public enterprises minister] Pravin Gordhan has spent the past nine months going through supply chain arrangements and auditing systems at SOEs. When something like this happens the SOEs tend not to spend. But these entities could make up as much as a quarter of the SA economy, and once the SOEs are spending again for the right reason there will be a pent-up demand. The floodgates could open … a little growth can go a long way at this point."
McLachlan points out that SA Inc stocks are "mind-bogglingly" cheap at present. "Cheap valuations with improved economic prospects are a potent combination for extraordinary returns."
He admits there could be more downside on the JSE, but points out that "the next bull market starts at the point of peak pessimism".
Preston agrees there’s "lots of beaten-up stuff" on the JSE, but is eyeing mainly turnaround situations or where value is set to be unlocked. "Look for a change in management, especially where a business has been run badly in the past."
He cites the example of Adcorp, which is showing vastly improved fortunes after a new management team was installed with the emergence of a new strategic shareholder. "This business was badly run in the past. Now margins are going up and expenses down. It will help further when the top line starts going up."
Independent small-and medium-cap analyst Anthony Clark says though the JSE’s small-cap index (J202) and mid-cap index are down only 13% and 15% respectively on a year-to-date basis, many smaller and medium-sized counters have been abandoned to the point that some are trading on low single-digit earnings multiples.
"Investors become wary of illiquid, domestic-focused stocks … and tar all with the same brush. Many companies that continue to perform well or have solid management and asset backing simply fall through the cracks and get sold off or drift down on lack of [market] interest."
Clark points out that the small-and mid-cap rout transpires periodically, and that these segments can recover spectacularly when the market realises that companies trading on earnings multiples of two or three actually have fair prospects.
"After the election in April 2019, I will bet on plenty of bottom fishing for recovery prospects in the small-cap bargain basement sector of the JSE. I can foresee some stocks doubling in value in short order."
Picking shares that could benefit in a recovery
If investors are brave enough to dabble on the JSE in these tremulous times, where are the best spots to place a bet on the local stock market recovering?
Neil Brown, co-head of Electus, says the JSE indices (all share and shareholder weighted) are the most undervalued they have been in more than five years, with a more than 20% upside based on “bottom-up” aggregation of all the company valuations undertaken by Electus.
He adds that the resources board is the only sector with a positive return (+11% since the beginning of 2018), and is now a fairly priced sector compared to all other major sectors that have fallen by more than 14%.
“Our funds will favour high-quality defensive rand hedges given the recent rand weakness. We will also hold selective local cyclicals as a number of these shares have been sold down substantially in the past few months and will benefit from any recovery in SA Inc.”
Brown says because interest rate-sensitive stocks — specifically banks and property — have also pulled back significantly, “we think it is also time to add some exposure in these sectors”.
Lentus Asset Management chief investment officer Nic Norman-Smith says perspective is important. “We have in recent years seen some crazy valuations on property and retail stocks as well as any companies with an aggressive offshore strategy. Now there is a lot of bad news out in the market. But we have been through worse periods. Markets are cyclical … they recover every time.”
Norman-Smith believes the gloomy mood on the JSE makes equity valuations look a lot more exciting. Of course, one can’t brush off the significant risk of further downside, and investors need to remain globally diversified. But there are more shares where it appears that the risk is already priced in.”
He concedes that trying to time the recovery on the JSE is a mug’s game. “It can get worse. But if investors buy the cheap out-of-favour stocks and hold these positions, the upside could be pretty exciting if the local economy steadily recovers.”
Norman-Smith says the popular retail sector is likely to get worse before it gets better.
“In this instance, it might be wise for investors to keep some powder dry.”
Cannon Asset Managers CEO Adrian Saville says if investors do their homework they will discover that some good businesses are still doing well in a weak economy. “Recalibrate the numbers and try imagining what the business could produce in earnings in better times.
“Look for companies that don’t have strained balance sheets, or are polluted by complicated accounting. Make sure there are cash-based earnings and not accounting earnings.”
RECM & Calibre CEO Piet Viljoen is wary of buying globally inclined SA stocks — even at lower prices. “Investors need global diversification. But do it yourself — don’t let listed corporations diversify for you. Any company that goes overseas, sell it. That’s not such a generalisation. There are not many that have made a success of [offshore expansion].”
Though there is currently an abundance of “deep value” and (dis)stressed opportunities on the JSE, Viljoen warns that investors dabbling in such counters must construct an uncorrelated portfolio. “Don’t put your eggs in one basket by backing a single sector.”
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