Equity market update May 2013
01 May 2013 - Quinton Ivan
Global equity markets rallied in the first quarter of 2013, with the MSCI World Index up 7.9% in US dollars. This is despite concerns over Europe’s recession and sovereign debt crisis, fears of a pronounced economic slowdown in China, and political shenanigans over the US’s fiscal position. It is clear in their actions to-date, that governments are determined to avoid the globe slipping back into recession and will be extremely accommodative. This will take the form of low interest rates, growth-oriented monetary and fiscal policy and general backstopping of any unforeseen threats to economic recovery that may occur.
Given this backdrop, interest rates are likely to remain at multi-decade low levels as authorities are prepared to tolerate higher inflation. In such a world, equities remain our preferred asset class to protect the purchasing power of our clients against rising inflation. We continue to prefer global over domestic equities. The valuations of global equities remain attractive, with many high-quality multinational companies growing their earnings and dividends at a steady rate and maintaining very healthy balance sheets. Our domestic balanced funds remain at the maximum 25% offshore limit.
Domestic equities, in general, remain fairly valued and we expect future returns to be more muted given the average industrial company’s high earnings base. The expectation of prolonged low interest rates has resulted in significant flows into high-yielding emerging markets as investors shun risk in their desperate search for yield. South Africa is no exception and, together with a ballooning current account deficit, is increasingly reliant on these capital inflows to balance the books. Notwithstanding the recent sell-off, the rand remains vulnerable to any reversal in foreign sentiment.
We therefore continue to favour high-quality global stocks that happen to be listed in South Africa, such as MTN, British American Tobacco, SABMiller, Naspers, Capital Shopping Centres (now Intu Properties) and Capital & Counties. All are attractively valued relative to pure domestic businesses. As at quarter-end, approximately 73% of our equity portfolios were invested in rand hedge counters.
The All Share Index returned 2.5% for the quarter. Industrials were the best performer with a 6.3% return. Financials returned 5.9% and resources lagged with a -6% return. Not only have resource stocks underperformed financials and industrials over 3, 5 and 10 years, they have also under-performed cash over these periods. We maintain a healthy exposure to resources in our equity and balanced funds, with selected resource shares trading at less than 10 times our assessment of normal earnings. Our preferred holdings remain the diversified miners (specifically Anglo American), Sasol and Mondi. We also continue to favour platinum over gold producers. Despite both facing significant cost pressures and increasing labour unrest, the pricing power enjoyed by South African platinum producers should protect earnings as metal prices adjust higher to incentivise new production. Our preference remains the low-cost producers – Impala Platinum and Northam.
Banks returned 1.8% for the quarter, underperforming other financials. While the current low interest rate environment has adversely impacted net interest margins, this has been offset by improving credit loss ratios. Current earnings for the large commercial banks now approximate our assessment of normal and we have used periods of share price strength to take profits.
In previous commentary we raised concerns over the high earnings base and ratings of consumer-facing businesses. Over the quarter, these concerns were somewhat vindicated as retailers were aggressively sold off, with the share price of the average retailer declining by close to 20%. Despite this recent decline, we believe current share prices do not provide an adequate margin of safety and we continue to hold virtually no exposure to retailers.
Looking forward, the investment environment is likely to remain volatile and challenging. While there are some signs of an economic revival in the US, prospects remain dire elsewhere; manufacturing activity continues to fall in Europe and the unemployment rate remains high. In a world where excessively low interest rates encourage investors to forget risk and focus too much on return, we remain committed to our proven philosophy of investing for the long term.
QUINTON IVAN joined as an equity analyst in 2005 and was appointed Head of Equity Research in 2012. He currently analyses retail, construction and pharmaceutical stocks and co-manages the Coronation Equity and Balanced Plus funds as well as Houseview Portfolios.
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Notes to the editor:
Coronation Fund Managers Limited is one of southern Africa’s most successful third-party fund management companies. As a pure fund management business it provides individual and institutional investors with expertise across Developed Markets, Emerging Markets and Africa. Clients include some of the largest retirement funds, medical schemes and multi-manager companies in South Africa, many of the major banking and insurance groups, selected investment advisory businesses, prominent independent financial advisors, high-net worth individuals and direct unit trust accounts. We are 29% staff-owned, have offices in Cape Town, Johannesburg, Pretoria, Durban, Gaborone, Windhoek, London and Dublin and are listed on the Johannesburg Stock Exchange. As at the March 2013 quarter-end, assets under management total R409 billion.