All good things come to an end. But if that end features a belligerent world power armed with nukes, an oil supply crunch, a broken global supply chain and runaway inflation, then the end of the good times may feel like a kick to the stomach.
Fears of a recession in the developed world, rising interest rates and signs of a bear market — at least among tech stocks and cryptocurrencies — have roiled investor confidence.
It’s severe enough that some punters have likened the situation to the 1970s, when Arab nations limited oil supply in response to Israel’s militancy in the Middle East. Only, this time around, it is Russia — the largest oil exporter to the global market, particularly to Europe — that is rattling its shasqua.
“Attitudes [regarding oil] are hardening due to the war,” Benguela Global Fund Managers chief investment officer Zwelakhe Mnguni tells the FM — which means the price “may remain elevated for the next 12 months”.
The swing has been dramatic: in early December, a barrel of Brent crude sold for $68.57; on March 8 it had almost doubled, to $123.48; and it was trading around $119 on May 31.
This alone has rattled markets, as the oil price has knock-on effects for almost every product. Transport, for example, has gone through the roof as a result: the low-sulphur fuel oils used in shipping have jumped from $659.50/t on December 1 to a record $1,063.50.
It’s a recipe for rocketing inflation.
Still, it’s not as if the world hasn’t seen this before. Back in the 1970s, the US Federal Reserve had to struggle with runaway inflation that went on to reach a peak of 14% by 1980, and which drove interest rates north of 20%.
The fear, this time, is that inflation may be here to stay for longer.
“Central banks are busy fighting inflation, as they should be. But they’re going to move hard and fast this time,” Luke Hickmore, investment director at UK-based global investment company abrdn, told clients in a note.
“The thing at the forefront of my mind is what turns this bear market around. Especially as it is a bear market for bonds, equity, credit, emerging markets, crypto — you name it.”
Some, however, believe we’ve seen the worst already.
Anchor Capital CEO Peter Armitage, for example, tells the FM inflation appears “close to the top”. This he ascribes to shale oil companies in the US “coming back” (many went bust several years ago when the price of crude tanked). Their return will lower the price of fuel.
Investors will be hoping Armitage is right. During the inflation peak of the 1970s, the US stock market lost nearly 50% of its value. In recent times, tech stocks have borne the brunt of the fear-induced sell-off.
The Nasdaq 100 index, which includes tech heavyweights Apple, Facebook-owner Meta, Microsoft, Google-owner Alphabet, Amazon and Netflix, has shed more than 24% this year. And unlike the sudden Covid crash in March 2020, the current decline has been gradual, tracking down since end-December, when the index traded at a record high.
One of the reasons for the slump lies in the way tech stocks are valued: through discounting future cash flows, using the expected inflation rate. This means that as inflation increases, the discount rises, leaving the valuation much cheaper.
Cryptocurrencies, some argue, follow a similar pattern.
“The crypto world set itself out as a hedge against inflation,” Citadel chief investment officer George Herman tells the FM. But, he adds, it turns out “that was not the case”.
In Herman’s view, the crypto realm can be more generally aligned with tech stocks. And, like their tech counterparts, cryptocurrencies have had a rough time. Bitcoin, for example, the tulip that bloomed most beautiful among its peers in the crypto frenzy, has more than halved, from $67,540 in early November.
These nontangible assets were always going to take a knock once the cheap money in the US began to dry up. And with the Fed signalling an aggressive approach to inflation, well, good luck to crypto investors.
More obscure than cryptocurrency is the nonfungible token (NFT) market, which trades digital ownership in digital art, profile pictures and gaming tokens. The NSN-ART20 index, which tracks the top-20 NFT art collections, has reversed 56% in dollar terms this year. If that’s not reminiscent of the tulpenmanie (tulip mania) in Amsterdam in the late 1630s, what is?
SA outperforms global market
The decline in more tangible assets, such as stocks and bonds, has been more mixed. Already expensive at the start of the rate-hiking cycle, the S&P 500 — which tracks the 500 largest companies by market cap in the US — is down 14.3% this year.
By mid-May, the gauge — which has about $5.4-trillion in passive assets indexed to it — had slumped 22%, wiping out more than a year’s worth of gains. But the Dow Jones, which is skewed towards value stocks, has dipped by just 10.2% this year.
“Equities have repriced quickly,” says Herman. “That is despite earnings keeping on growing and forward p:e [valuations] not being expensive. Despite inflation, we remain positive on equities.”
Locally, investors have braced for the worst.
By May 30, the FTSE/JSE all share index had slid 2.9% this year. But strip out the large offshore earners — Naspers and Richemont, for example — and the mid-cap index was almost unchanged. This may be explained by the relatively cheap valuations at which SA Inc companies traded before the international market turmoil hit.
In comparison with US equities, SA stocks mostly trade at single-digit p:e valuations, making them cheaper than their overseas counterparts.
“We prefer SA assets over US equities and US bonds,” says Old Mutual Investments portfolio manager John Orford. “US valuations are very high.”
But the big question is: how badly will local stocks and bonds be affected by the Reserve Bank’s actions to rein in inflation? Much depends on whether the Bank has the stomach to hike rates, even if doing so triggers a recession locally.
At its May monetary policy committee meeting, the Bank revised SA’s growth estimate down to a paltry 1.7%, from 2% in March. It also said it expects inflation to clock in at 5.9% this year — well above the 4.5% midpoint of its target band.
“The Reserve Bank is more in tune with the economy and consumers,” says Herman.
Armitage reckons it can’t keep hiking rates, though. Since November, it has already done so four times — taking the repo rate from 3.5% to 4.25%. “It can’t put interest rates up by much more,” he says.
On the flipside, Bronwyn Blood, portfolio manager at Granate Asset Management, says there are several risk factors weighing on SA’s inflation outlook. “We are starting to see pressure,” she says. “We’ve had load-shedding, we’ve had the floods in KwaZulu-Natal. You name it. Everything has been thrown in our way.”
All these obstacles weigh down economic growth — which means Blood’s not sure “the Reserve Bank can afford to hike so aggressively”.
A cocktail of high inflation and low growth raises concerns about stagflation — rising inflation with stagnant economic growth — similar to what happened to the US in the 1970s. With emerging-market central banks having started their interest-rate hiking earlier than developed markets like the US, the speed of rate hikes now matters.
Benguela’s Mnguni worries that emerging-market policymakers won’t have much manoeuvrability when the Fed, for instance, starts to battle inflation with more fervour.
“We may get an autopilot scenario,” he says, referring to a situation where the Reserve Bank hikes rates more vigorously in a bid to protect the rand. “The Fed must act, and it will put pressure on emerging markets,” he says.
Since February this year, emerging markets have raised their interest rates to an average of 5% — 75 basis points (BPS) higher than the beginning of the year, according to the International Monetary Fund. This seems to have halted emerging-market portfolio outflows, data shows.
SA has been luckier. In the first three months of the year, foreigners were net buyers of R32bn of stocks and bonds. But whether that trajectory continues remains to be seen.
Ports in a storm
Where does this leave investors? Should they opt for overvalued offshore stocks, cheap local equities or bonds?
Or have value investors — who pick stocks with stable earnings growth and solid dividend payments — been redeemed at the cost of hyped-up growth stocks?
“You’d want to be divorced from economic sensitivities,” Sumesh Chetty, portfolio manager at Ninety One, tells the FM.
As he tells it, there are two types of investors in markets this turbulent. The first has a through-the-cycle mentality, tolerating swings and believing their holdings will do decently over the long term. The second also invests for the long term, but is more sensitive to short-term blips. Both types of investors would have needed grit not to yield to the noise around growth stocks.
“In 2021 you would have had a lot of fomo [fear of missing out],” Chetty says. “You’re at a braai with your mates. Your mates are invested in [a] Cathie Wood fund and you’re sitting there with Johnson & Johnson and Nestlé, and you may be 20%-30% behind Cathie Wood.”
Now the tables have turned.
Wood’s ARK Next Generation Internet ETF, with $2.4bn under management and which invests in cloud computing, big data, digital media, e-commerce and blockchain technologies, is down 45% this year — erasing two years’ worth of returns.
Compare this with the Vanguard Russell 1000 Value Index Fund ETF, with $8.6bn under management and laden with value stocks. It holds companies such as Johnson & Johnson, Procter & Gamble, Chevron, Pfizer and Merck — and is down just 8.2% this year.
Locally, it is harder to pick out the value from the growth stocks. This is mainly because local stocks were already cheap compared with other markets, based on p:e valuations and dividend yields, before this bout of turmoil. Throw in a commodity price rally, and a resource-laden stock market like that of SA, and it skews the picture.
“SA is fortunate,” says Herman. “[The country’s] inflation dynamics are more benign than the West’s. SA has the benefit of higher commodity prices.”
So if the prospects locally aren’t all dire, where are you likely to extract more value? Where should SA investors be putting their cash?
Finding value in food
One local sector that may benefit from higher inflation is food retail. Over 12 months Africa’s largest grocer, Shoprite, returned 39.4%, including dividends. Since the beginning of the year, it’s up 1.2%. Pick n Pay, with its aggressive push into lower-income households, rose 5.1% since the beginning of the year.
The question now is: can food producers, like Tiger Brands, continue to accept hard bargaining from their retail counterparts and hike their prices?
“Food producers can’t shock retailers and consumers, and they’d want to protect their market share,” Absa Asset Management portfolio manager Kurt Benn tells the FM. But, for producers, the availability and price of raw materials are “quite important”, he says.
Or, as Mnguni puts it: “It’s only when there are shortages that retailers become price takers.”
Soft commodities, including maize, wheat and sunflowers, have seen sharp price increases. The war in Ukraine has put shipments of that country’s wheat (10% of global exports), maize (11%) and sunflower seeds (almost 40%) at risk.
Fertiliser exports, mainly from Russia, are also under pressure (the country ranks among the top two exporters of nitrogen, phosphor and kalium).
A shortage of fertiliser is already being felt by SA fruit farmers. “You take the fertiliser you can get now,” says Abrie Pieterse, a grape farmer from the lower Orange River. “The price ... has doubled over the past year.”
Alec Cutler, who helps manage the Orbis OEIC Global Balanced Fund, believes some of the blame for the fertiliser crunch can be laid at the door of the ESG movement.
“The ESG movement didn’t distinguish between natural gas and oil, and forgot that fertiliser is made from natural gas,” he tells the FM.
With looming food shortages across the globe, Orbis has been investing in crop science heavyweight Bayer. “We’re also investing into Brazil as [the world] needs to produce more food,” he says.
Locally, fertiliser producer Omnia has returned 35.3% to shareholders since the beginning of the year, and is now trading at a p:e of 16 and dividend yield of 2.3%.
The price of yellow maize for delivery in September is also up — from R3,677/t on January 3 to its closing price of R4,820/t on May 30, a 31% increase. Yellow maize is responsible for about 60% of the cost to produce a broiler chicken.
But Astral Foods, SA’s largest listed poultry producer, said at the release of its results for the six months to April that it has partially recouped higher input costs. Higher sales volumes, especially to quick-service restaurants, have helped.
RFG Holdings and Tiger Brands both reported on May 25 that they aim to push higher input costs through to their customers: food retailers. “[RFG’s] ongoing focus is on recovering increased input costs from the market and generating operating efficiencies to counter the impact of cost pressure on margins,” the company said.
Tiger Brands, SA’s largest food producer by sales, said much the same. “Significant price increases across most of the portfolio are inevitable,” the company said on May 25. “Inflation in the second half is likely to run into double digits, with the full impact of this on consumer demand for our brands a key unknown.”
Astral’s share price returned 12.4% this year, and it is trading at a p:e of 9.3 and dividend yield of 6.4%. RFG trades at a more expensive p:e of 10.1, while investors have been more benevolent towards Tiger Brands, whose share price rose 4.8% on the day it released its half-year results. It was trading at a p:e of 12.4 and a dividend yield of 5.8%.
With impending price increases for food, SA farmers have stepped in to increase the winter crop plantings for wheat. At its April 26 meeting, SA’s crop estimates committee forecast that 538,350ha of wheat will be planted this winter. This will be the biggest area planted since 2019. Similarly, the maize crop is expected to be 14.72Mt — 10% smaller than last year’s harvest, but still bigger than the five-year average of 14.44Mt.
“SA produces enough food,” says Herman. And with the maize crop sufficient to fulfil local consumption needs, this may contribute benevolently to food price inflation (estimated at 6.6% by the Reserve Bank in May).
Looking to local bonds
With inflation for 2022 expected to touch the upper limit of the Reserve Bank’s target, one might think government debt would be a bad bet. Inflation is not benign to bonds, as it erodes the present value of the underlying capital over time. When investors reckon inflation will rise, they demand a higher yield to compensate for the erosion of capital.
But SA government debt has been cheap (or, rather, yielding high returns) since before the current market malaise. Bonds, which pay a fixed coupon (or interest) rate, have come to the fore as less risky. The yield on government bonds maturing in 10 years declined 15.5BPS over the six months to May 30, to 9.62%.
“You are getting very attractive real yields,” Blood tells the FM. “A lot of risk is already priced into our bonds.”
Her fund house recently launched an actively managed SA bond fund. “If you’re looking for the most certain [investment] outcome, it is certainly the local bond market,” she says.
At a yield of 9.62%, the 10-year nominal bonds deliver a real return of 3.72%, once inflation is stripped out.
As Armitage puts it: “These yields, with no risk of not getting paid back, are unusual to find.”
There is another bond class attracting attention from fund managers: inflation-linked bonds, which pay a fixed rate above the variable consumer price inflation.
“Given the uncertainty, it is even better to be in inflation-linked bonds,” says Blood. “First, they’re not owned by global investors” — so if markets do go further south and risk-averse foreign investors sell out of local bonds, the nominal bonds will suffer, she explains. “[Inflation-linked bonds] are not under the same selling pressure.”
Second, these bonds protect investors against inflation. “As inflation rises, your return rises,” she says. “You’re guaranteed an inflation-plus return.”
The defensives
With war returning to Europe and oil prices blowing out, various gems have surfaced.
First, are the defence companies. There has been a big shift in war spending towards more cost-effective European defence companies, such as Sweden’s Saab, Germany’s Rheinmetall, French company Thales and the UK’s BAE Systems. The losers have been US heavyweights including Lockheed Martin, Boeing, Raytheon Technologies and Textron.
Investors have taken note. The Stoxx Europe total market aerospace & defence index, which tracks 25 large European defence and aerospace companies, has risen 5.9% this year. Over the same period, the Dow Jones US select aerospace & defence index, an American gauge of defence and aerospace companies, fell 0.47%.
This year, the Stockholm-listed Saab has returned 86% to investors, Rheinmetall, known for building tanks in World War 2, has returned 135%, while Thales, which will soon be in the dock with former president Jacob Zuma in SA, returned 56% this year.
Oil companies aren’t faring too badly either. Global crude supply remains tight, amid fears that the transition to noncarbon energy sources may accelerate.
“Inventories around the world are shrinking,” says Cutler. With little investment in additional supply over the past decade, the oil squeeze is now fuelling inflation around the world.
Shell has risen 48% this year, while BP has returned 21.5%. On the flipside, TotalEnergies had a meagre return of 5.7% this year, but has delivered a sturdier 61.7% over 12 months.
There are other stocks that offer benefits regardless of economic pressure.
What it means: The rocketing costs of fuel, transport, shipping and food will be felt around the world.
— What it means:
For Chetty, British American Tobacco hits that mark. It’s a good dividend-payer, the stock has returned 20.8% in rand terms to investors this year, and it pays a dividend of 6.1% of its share price, he says.
Mnguni says gaming and electronic sports companies may also be a good buy. Such is the appeal of these companies that Activision Blizzard — which owns money-spinning games Spyro, Call of Duty, Candy Crush, World of Warcraft and StarCraft, and which has a market cap of $60.2bn — struck a merger deal with Microsoft in January.
Electronic Arts, which owns the Fifa, Sims and Command & Conquer gaming franchises, returned 4.1% this year amid the tech sell-off, to trade at an expensive p:e of 50 with a dividend yield of 0.6%.
SA investors will be hoping this bodes well for a recovery in Naspers and Prosus, which are invested in the Chinese gaming giant Tencent. Both JSE-listed firms have fallen 46% in the past 12 months — caught in the vortex of negative sentiment towards China and tech stocks.
The point, however, is that even in a world upended by conflict and soaring fuel prices, there are still investable assets to be had.
“You don’t know where interest rates are going,” says Chetty. “[But] there is potentially a lot of risk. [In a recession], you start to hunt for opportunities.”
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