Q&A with Karl Leinberger

03 March 2014 - Karl Leinberger

Karl Leinberger is chief investment officer at Coronation Fund Managers.

After a number of years of strong gains on the JSE, some analysts are predicting a pullback in 2014 — do you share that view?

We don’t take a short-term view on equities at Coronation so all my comments really look at a longer-term horizon. We think the JSE is pretty fully valued as it stands so we have quite low exposure to local equities across our asset allocation funds. Although ratings have come off over the last year, we still think that on the whole the local market is a little pricey for us.

What have the drivers behind the gains on the JSE been — and do they remain in place?

First, corporate South Africa has performed well for many years so companies have delivered strong earnings. Companies have been well managed and have kept costs under control, which has resulted in decent bottom line results for shareholders.

Second, we have had an environment of easy money across the world due to accommodative monetary policy in developed countries. Investors in these countries have been looking at emerging markets for higher yields and returns than they can achieve at home. So you had a combination of good underlying earnings performance and increased ratings as international investors were prepared to pay more for South African assets.

So what has changed since then?

Over the past year the trend has reversed with both earnings and ratings coming under pressure. The economic environment has become tougher and companies are finding it increasingly difficult to defend their high earnings bases. In addition to this, ratings have come off as international investors have sold in response to a weaker outlook and a marked deterioration in the fundamentals for corporate South Africa.

While the JSE rose strongly in rand terms last year, in dollar terms it was actually down. Does this make it more attractive for foreign investors?

I think that if the price of any asset is lower it has to be more attractive than if it was higher.

So to a rational international investor, the fact that it’s down should make our stocks offer more value. However, many investors follow the momentum, which appears to be against us.

The strong rise in our market in rand terms last year was really driven by the rand-hedge stocks — global stocks listed on the JSE including stocks like SABMiller and Richemont.

A lot of our domestic stocks haven’t done well over the past year, such as retailers and banks and general industrials, including Imperial and the like. Those shares have all battled due to deteriorating economic fundamentals and a reversal of the aggressive buying by foreigners over the past few years.

There has been a shift in sentiment from emerging to developed markets. Is this likely to affect returns on the JSE in 2014 — and are emerging markets likely to be grouped together regardless of the different fundamentals of individual markets?

I think in the short term there’s a very high correlation between emerging markets, but there are massive differences fundamentally between them and those fundamentals will assert themselves in the long run.

Some of these emerging markets run massive deficits, while some run surpluses; some are resources-heavy, some are not; some are well managed and some aren’t.

In the short term, though, investors tend to follow each other.

Where does South Africa stand in all that?

I would say that a lot of our fundamentals are weak and are deteriorating. The one important point on South Africa when it comes to equities is that when you benchmark us with our peers our companies are incredibly well managed so that is a counter weight to the broader observation that the environment they operate in is deteriorating.

With the overall market looking expensive relative to its historical average, are there any particular sectors on the JSE that offer value for investors and are likely to perform better in 2014?

We would consider a lot of things other than just its price earnings multiples and again, we don’t take a short-term view. What is interesting is that a lot of consumer-facing and domestic stocks have sold off a lot, some between 30% and 50%, and we are starting to see value emerging in some of those stocks.

Some of the rand hedges that have done well are offering less value than they did in the past though.

Will we see sector rotation in that case, with investors moving back into the likes of banks and retailers?

I don’t believe that international investors are going to want to own these businesses for a long time. We are starting to see value in them, but cycles usually take a while to play out and I would say we are only a year into this downturn.

With the companies that have run hard, including the rand hedges, are their earnings likely to justify high valuations?

There are some rand hedges that are fully priced and we have sold out of many of these. But there are still some, like British American Tobacco and Mondi, that we still think offer good long-term value.

How much of our performance is contingent on how quickly the Federal Reserve scales back its quantitative easing?

I don’t know. We don’t obsess about how and when it’s going to be withdrawn. We do know that the environment that we have been in over the last few years has been abnormal and the long-term environment is going to be very different. Companies and markets, countries and consumers are going to have to get used to higher interest rates. And that’s the big change.

Zero interest rates was fun for a while but the big trick is in understanding what the ultimate end-game means for companies and markets rather than trying to forecast exactly how and when we will get there.

Is the rand also an important factor to consider in 2014 for JSE investors?

We pay enormous attention to what we think the long-term outlook for the currency is. We have no way of knowing whether it’s going to average R10 to the dollar or R12 to the dollar this year. We think the currency actually offers a bit of value and we think the selloff is overdone.

In terms of its long-term value, we think fair value is closer to R10 to the dollar.

How about South African investors looking offshore — are they likely to get better returns in London or New York?

Global equities have done a lot better than South African equities over the last few years and we think they still offer better value. We have been positioned like that for many years and we still hold that view.

We believe that global equities are pretty fairly priced in an environment where we feel the outlook for bonds and cash and other major asset classes are quite weak.

Global equities remain our favoured asset class, whether you are looking at developed or emerging markets, we think there is pretty broad value out there.

​What sort of returns are South African equities likely to deliver?

As a whole, South Africa is still expensive for what you are getting so we don’t think that long-term returns are going to be that good — perhaps in the high single digits.