Equity market update
01 October 2013 - Quinton Ivan
Chairman of the US Federal Reserve, Ben Bernanke, signalled to the market in May that it was contemplating an exit from its aggressive quantitative easing policy. Markets reacted violently to the news in what is now known as the ‘taper tantrum’. US bond yields spiked dramatically and emerging market bonds followed. The US dollar strengthened, the gold price fell sharply and most emerging market currencies weakened.
We highlighted in our previous commentary that authorities are unlikely to sit back and watch bond yields kick up too quickly and risk stifling growth. In September, the FOMC (Federal Open Market Committee) meeting announced a delay to tapering, citing low inflation and some doubt over the strength of the US economic recovery. Bond yields fell on the news and markets rallied strongly.
There appears to be no end to market volatility and at the time of writing, the US government shutdown has entered its second week (with little sign of resolution between the Democrats and the Republicans over the budget). This means that fiscal policy will remain too restrictive given the sluggish growth of the economy. This, in turn, means that the full burden for stimulating the economy will rest squarely on monetary policy. Consequently, the unwind of quantitative easing is likely to be slower, and interest rates are likely to remain lower for longer. In such an environment, equities remain our preferred asset class for producing inflation-beating returns. We continue to favour global over domestic equities. The valuation of global equities remains attractive with some of the world’s best companies trading on compelling PE multiples, with fortress balance sheets and all the while growing their earnings and dividends at a steady rate. Our domestic balanced funds remain at the maximum 25% offshore limit.
Domestic equities, in general, remain fairly valued. We continue to favour the quality global stocks that happen to be domiciled in South Africa, such as MTN, British American Tobacco, Naspers and SABMiller. Although these shares have performed extremely well relative to the broader market, they remain attractive based on our assessment of their intrinsic value and particularly attractive relative to pure domestic businesses. British American Tobacco and SABMiller are high-quality global consumer staples. They have robust business models, are diversified across numerous geographies and currencies, and enjoy immense pricing power. They trade on similar ratings as their global peers and will comfortably grow earnings in real terms. We continue to have meaningful positions in both stocks.
As valuation-driven investors, we are comfortable owning shares that trade on high near-term PE multiples, provided that the PE multiple based on our assessment of normal earnings is attractive. This is the case for Naspers. The current and near-term earnings of Naspers are depressed by significant investment into the pay-TV business (as it grows its subscriber base) and Tencent (as it aggressively builds its e-commerce platform). Longer term, however, we believe that this investment will create significant value for patient shareholders. At quarter-end, approximately 70% of our equity portfolios were invested in rand-hedge counters.
We have owned very few domestic businesses, especially consumer-facing, on the basis that valuations were not attractive. This view has been vindicated thus far, with retailers among the worst performers in 2013. We have used further weakness to increase our holdings in The Foschini Group and Clicks Group. While the earnings base for both businesses remains high, the ratings are attractive, providing an adequate margin of safety to build a position in these counters.
The All Share Index returned 12.5% for the quarter. Industrials returned 11.3% and financials 6.9%. Resources were the best performer with a 19.7% return. Over the long term, however, resources have underperformed the All Share Index over three, five and ten years. We maintain a healthy exposure to resources in our equity and balanced funds. Our preferred holdings remain the diversified miners (specifically Anglo American), Mondi Limited and Sasol. We continue to favour platinum over gold producers and our preference remains the low-cost platinum producers, Impala Platinum and Northam.
Banks returned 11.5% for the quarter, outperforming the broader financial index. Net interest margins should benefit once interest rates are eventually hiked. While this will be offset by rising credit loss ratios, banks have used the current environment to bolster general provisions, which should blunt some of the impact. Current earnings for the large commercial banks approximate our assessment of normal. Valuations are reasonable and we have maintained our weighting. Life insurers, on the other hand, currently trade on premiums to their embedded value and do not offer value.
Volatility in financial markets is likely to be influenced by political brinkmanship, particularly out of the US. The absence of any immediate compromise between the Democrats and Republicans adds to investor uncertainty, as a failure to reach a separate agreement to raise the debt ceiling by 17 October will result in a US default. Financial markets have so far reacted relatively calmly to the impending debt deadline; however, a default could inflict significant damage on financial markets and the global economy. As long-term investors, we strive to ‘cut out the noise’ and capitalise on any mispriced opportunities that may present themselves.
Quinton Ivan joined Coronation 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 25% 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 2013 quarter-end, assets under management total R492 billion.