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At our recent Investor’s Guild, we debated whether all the “rational” investors out there are on to something with all the uncertainty taking over every other headline article – or whether it’s business as usual. In my opinion, when it comes to investing and the market, it should always be business as usual. Every year investors find at least one thing to panic about and as Mr Market has proven time and time again, it will always come out stronger (see Image 1). That, however, doesn’t take away from the fact that there is a lot of uncertainty in the market currently, so let’s look into some of these factors and the importance of your time in the market.
Image 1 - Source: Miltonfmr
Eskom & Rail Freight in South Africa
In South Africa, there is quite a bit happening. So, let’s start with what’s most probably keeping everyone awake at night… Eskom.
Electricity supply by Eskom has deteriorated by close to 10% (see Figure 1) over the last year. This is at a time when South Africa could be capitalising on higher-than-average commodity prices as one of the biggest commodity-producing economies in the world. This, together with the issues they’ve been experiencing with rail freight network constraints (see Figure 3), has had most miners caught between a rock and a hard place. Some of you might ask why I’m not a bit more optimistic seeing that most companies operating in South Africa should have their own sustainable energy generation capabilities by now.
Over the last 2 decades, the energy intensity of South African GDP growth as a whole has declined by over 30%. What this essentially means, is that the South African economy is 30% less reliant on Eskom than it was at the start of the new millennium (see Figure 2). But, it’s important to understand the impact that this has had on South African businesses as everything in life comes at a price.
The ultimate price companies have had to pay for this “luxury” is an increased cost base and squeezed margins. This has therefore had a direct impact on the earnings of companies operating in South Africa, whether it be in the form of forced downtime due to electricity supply constraints or the private generation thereof.
Figure 1: Electricity supply by Eskom - Source: Eskom
Figure 2: Energy intensity of GDP in South Africa - Source: Eskom
Figure 3: Poor rail freight network - Source: Transnet/Fitch Solutions
Protest and Strike Action
Another unique factor when it comes to investing in South Africa is the level of protest and strike action we see every year. Protest levels in 2022 have made a sharp comeback and we’re pretty much back to pre-COVID levels (see Figure 4). Strike action has only increased slightly but I think it’s safe to say that the expectation going forward will be for more normalised strike action as consumers continue to face inflationary pressures (see Figure 5). The effect that these 2 events ultimately have been lost workdays, an increased cost base, and a direct impact on the revenue generation capability of these businesses.
Figure 4: Protest levels in RSA - Source: Municipal IQ/Andrew Levy Publications/Standard Bank Research
Figure 5: Strike action in RSA - Source: Municipal IQ/Andrew Levy Publications/Standard Bank Research
Red Flags in the Rest of the World
From the rest of the globe’s perspective, there are quite a few red flags as well. According to Bank of America’s Global Fund Manager Survey (see Figure 6), a systemic credit event is at the top of the list of concerns for investors following the Silicon Valley Bank debacle. Inflation concerns remain quite elevated and geopolitics seems to be worsening – but what I found quite interesting is the last 2 items in this figure. Both risks from a deep global recession and a stock market crash have almost disappeared from the list and don’t seem to be taking up much of the think banks of investors across the seas.
Figure 6: Biggest tail risks to investors - Source: BofA Global Fund Manager Survey
Investors are concerned about the prospect of negative earnings revisions going into the second half of the year (see Figure 7), but I think it is important to note that most companies are coming off a high base. Negative earnings revisions have in the past been a leading indicator for further market pressure and stock prices to trend downwards, yet it remains difficult to ignore the amount of money that investors are still sitting on in the form of “dry powder”. Money Market funds in the US are at all-time highs of $5.2 trillion (see Figure 8) and it’s simply unrealistic to expect this to be the new norm. At some point in time, these funds will ultimately find their way to the stock market as we’ve already seen from an overallocated mega tech space in the US (see Figure 9).
Figure 7: Global Earnings Per Share (EPS) growth revisions - Source: BofA Global Investment Strateg/Bloomberg
Figure 8: US Money Market Funds ($’billions) - Source: Source: Arysteq/Bloomberg
Figure 9: Size of Mega Tech in NASDAQ100 - Source: Genuine Impact
Inflation
Inflation staying high is a real concern for most developed nations across the globe who are simply not used to the idea of prices increasing regularly. For the rest of us back home, the belts may have had to be pulled tighter but this is not our first rodeo.
Inflation in emerging markets is a normal occurrence and the comfort level is probably a more important consideration when it comes to households in Namibia and South Africa. The problem being faced by consumers across the globe relates to a new catchphrase termed “Greedflation”. This is essentially when companies increase prices by a lot more than what is necessary to absorb the increased cost pressures from higher labour and non-labour inputs into their cost of production. Their margins can then be significantly expanded, and record-level profits usually follow – a headline we’ve been seeing relatively more over the last couple of months. This comes at a time when consumers are already under pressure with increased credit card costs, higher mortgage payments, and car loan repayments. So, the bigger concern is most probably the level of defaults we can expect to see going forward and at which point consumer spending will change from wants to exceptional needs only.
Another challenge with inflation that most of my friends and family seem to be missing is the fact that life expectancy is increasing across the globe. In the years 1960 to 2020, life expectancy increased noticeably worldwide. Starting at 50.7 years in the sixties, it has increased by 19.1 years to 69.8 years for men. For women, life expectancy increased by 20.3 years from 54.6 up to an average of 74.9 years since 1960. This can be attributed to many things but in a nutshell, people are living healthier lives overall. Developments in big pharma have made most conditions treatable and technological advancements have reduced much of the strain our forefathers had to endure. This means that longevity risk is becoming a real concern for most aging folks and we need to pay attention to where we invest our hard-earned funds.
So how do you manage your portfolio through all of this and position yourselves going forward?
To answer this question is unfortunately not a one-size-fits-all and depends on the risk and return objectives of every individual – but if your gut is telling you to withdraw all funds from the market and invest it in Money Market… please don’t.
As I mentioned at the start of this article, there will always be some sort of panic event in the market and how you react to it will determine the return number you see on your holdings statement at month end. The age-old saying “silence is sometimes the best answer”, is sometimes true for investments too – sometimes not doing anything at all may just be the best thing to do for your portfolio.
Many times, investors try to time the market by trying to sell at the top and get back into the stock market at the bottom, but this seldom ends well. Figure 10 below illustrates this exact point and again just proves to me the importance of staying your course in the market, rather than trying to time the market. I find it quite staggering that missing out on just 50 of the best days over the last 40 years can more than half the annualised return of your portfolio!
Figure 10: Cost of missing the best days - Source: Fidelity
Money Market funds are not a bad investment vehicle and the risk of losing your capital is close to zero but from a risk-adjusted return perspective, it is not the product to use for longer-term investments. To grow and maintain your purchasing power, equities have proven to be the best solution. So, assuming that you’ve concluded that you have an appetite for taking market risk, below I discuss how we ensure that, in our portfolios, we are cushioned to a large extent, but remain invested to take advantage of all upside opportunities.
Emphasis on High-Quality Businesses
We’ve positioned our portfolios with businesses that have strong management teams that have demonstrated sound track records, durable and competitive business models, and stable financial positions. In our analysis, these businesses have demonstrated in the past that they can sustain challenging market conditions and uncertainty.
This does not mean that our funds will not be affected by downturns in the overall market, but our portfolios are naturally more defensive than the overall market, meaning that in times of market stress, we tend to outperform. A case in point is that in 2022, the Arysteq Global Opportunities fund had a 1-year net return of -5.1% vs that of the MSCI World Index benchmark at -12.0%. We’re constantly reviewing the construct of the portfolio and have invested our portfolios in businesses with strong fundamentals – essentially looking for the best companies with the strongest durable business models and cash generation power.
Insuring our Portfolios
In addition to our portfolio positioning, we have also developed a model to help us detect severe market calamities and volatility. This model, which has predictive characteristics over the long term, is a handy tool in ensuring that when we expect such volatile market conditions, we are able to buy insurance against it. This provides an extra layer of protection in all our fund products.
In conclusion, history has proven that in times of uncertainty, when you are invested it is best to stay the course – assuming that your investment objectives haven’t changed and to ensure that you understand the investment process of your selected investment manager.
In investments, less tends to be more and so it is also better to avoid being trapped in the prevailing thought. As an example, many that we are speaking to seem to be discussing recessions as a high-probability event. While there is always a risk of recession, we don’t see it in the foreseeable future in Namibia or the world. In fact, the fundamentals of the Namibian economy seem to be changing for the better as data keeps improving each month.
