Equity market update - 2012
01 October 2012 - Quinton Ivan
Equity market update
By Quinton Ivan, head of equity research
There is a sense of déjà vu as the economic and financial outlook continues to be clouded by the eurozone crisis, faltering economic recovery in the US and fears of a hard landing in China. Notwithstanding these lingering concerns, financial markets climbed higher, with the MSCI World and Emerging Market indices returning 6.8% and 7.9% respectively for the quarter.
Risk appetite returned when Mario Draghi, the European Central Bank (ECB) president, announced that the bank will do ‘whatever it takes within its mandate’ to preserve the eurozone. While the risk of a disorderly breakup of the euro has reduced, continued austerity will mean that low economic growth (and possibly recession) will be the likely outcome.
In China the central bank has begun to ease monetary policy to stimulate economic growth, but the risk of a hard landing remains. As a large consumer of commodities, this is likely to place pressure on commodity prices and resource shares.
The US Federal Reserve announced another round of quantitative easing to boost the faltering economy, which is being hampered by political dysfunction in the run-up to the November 6 general election. We remain positive on the US economy, which is well diversified and has a better capitalised banking system than its European peers.
It is our view that highly accommodative fiscal and monetary policy will manifest in higher inflation in the future, and thus equities remain our preferred asset class for producing inflation-beating returns. We continue to hold what we consider to be a slightly underweight equity exposure. Despite the significant uncertainty in global markets, the FTSE/JSE All Share Index is at an all-time high. This, coupled with our view that domestic equities are fairly valued, does not justify higher exposure. Global equities, on the other hand, remain attractive with many multinational blue chips trading on attractive PE multiples and healthy dividend yields. We continue to hold close to the 25% offshore limit in our global balanced funds.
South Africa’s competitiveness as a nation has declined over the years. This is symptomatic of a highly inflexible labour force that has consistently received real wage increases without the commensurate productivity gains. The recent events at Marikana, while tragic, will result in a structural increase in labour costs and level of social spend required in the mining sector – a sector already under pressure due to falling commodity prices. The wage settlement reached (despite an existing agreement in place) calls into question the validity of other existing wage agreements, and labour unrest is unlikely to be contained to the mining sector. At the time of writing, the transport sector and some car manufacturers are on strike. The lost mandays place further pressure on a country already living beyond its means as shown by the large current account deficit. We are becoming increasingly reliant on foreign flows to balance the books. This is simply not sustainable. The rand remains vulnerable given these concerns and we retain a high exposure to attractively valued, rand hedge investments such as MTN, Naspers, SABMiller and British American Tobacco.
The All Share Index returned 7.3% for the quarter. Industrials were the best performer with a 10.5% return, financials produced 6.5% and resources lagged at 2.9%. Resource stocks remain under pressure given concerns over the slowdown in China as well as the current labour unrest dominating local and international media. We continue to find value in selected resource stocks, trading at less than 10 times our assessment of normal earnings, namely Sasol, the diversified miners (specifically Anglo American) and Mondi. We have also started buying platinum producers, Impala and Northam.
Banks returned 1.9% for the quarter, underperforming other financials. Despite giving up some of the earlier gains during the quarter, banks have returned 21% year-to-date, outperforming the market. We still retain a significant holding on the basis that valuations are fair at 10 times our assessment of normal earnings and price-to-book ratios of 1.8 times, especially when compared to highly valued domestic industrial equities. While inflation is currently contained within the SARB’s target band, significant upside risks remain. As such, we remain defensively positioned by owning companies with quality franchises, pricing power and robust business models that are capable of defending and growing their earnings base in real terms. We continue to be cautious on consumer-facing businesses. The share prices of retailers have been bid up by aggressive foreign buying; foreigners now own roughly 40% of most South African retailers. Current valuations combine a high rating with a high earnings base and do not offer a sufficient margin of safety. We continue to find value in selected small caps with approximately 29% of equity invested outside the ALSI 40.
The disconnection between economic reality and financial markets is likely to persist, driven by the current global zero interest rate policy. Volatility will also persist as markets react to the news of the day.
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 September 2012 quarter-end, assets under management total R339 billion.