Geo-political soap operas:

game changers or noise?

ON THE WORLD STAGE

We heard from Daniël that following the protest votes in the UK and the US, which gave us Brexit and Donald Trump respectively, the world is watching with a keen eye the outcome of several highly significant European elections this year. Across the continent, the liberal world order so carefully crafted after World War II is under siege, with mainstream parties losing their grip on power to populist fringes – mainly far right – as citizens protest the perceived negative effects of globalisation and an economic model many believe benefits only an elite few.

The populist vote fell well short in last week’s parliamentary election in the Netherlands, with conservative Prime Minister Mark Rutte successfully seeing off a challenge from the ‘Dutch Trump’ –nationalist firebrand Geert Wilders. Some analysts have suggested the stormy start to Trump’s presidency may have dampened support somewhat for the more radical European populist movements. But electoral showdowns are still looming in France, Germany, and possibly Italy, where right-wing parties are all still in with a fighting chance of staging major upsets.

Meanwhile, across the English Channel, Britons are gearing up for what is likely to be an extremely messy divorce from the European Union (EU). Prime Minister Theresa May is about to trigger Article 50, which will start the two-year countdown to Brexit.

What impact is this likely to have on the UK economy? The pound fell dramatically after the Brexit vote in June last year and has since then lost around 20% of its value. Interestingly, the equity market has reacted positively and is now up by about 16%. There have, however, been reports of an EU ‘exit bill’ which will cost British taxpayers in the region of £50 billion – a figure surely not envisaged by Brexit campaign leader and now Foreign Secretary Boris Johnson.

Across the Atlantic, the ‘disruptive president’, as Trump has been labelled, continues to do exactly that. He is putting paid to earlier assumptions (and hopes) that he may not follow through on some of his more radical campaign promises, and is ruffling feathers both at home and abroad. As The Washington Post has put it: ‘Trump is governing almost exactly how he said he would during a campaign that he won. No one should be surprised.’

Not everything is doom and gloom under Trump, however. If he continues his pledge to build infrastructure, and lower both corporate and individual taxes, it would certainly provide a boost for the US economy over the short term. Whether he will actually succeed in his campaign promise to ‘make America great again’ however, only time will tell. With the rest of the world, we’ll just have to wait and see.

OUR OWN SOAP OPERA

Back home, we have our own serial dramas keeping us riveted. With an ANC policy conference toward mid-year and the party’s elective conference at the end of 2017, the gloves are off between the main leadership contenders: former African Union Commission Chairperson Nkosazana Dlamini-Zuma and current Deputy President Cyril Rampahosa. National Assembly speaker Baleka Mbete has also thrown her hat into the ring. So we’re in for some interesting months ahead as the succession battle takes on gladiatorial proportions.

What is concerning is the number of epic blunders by Zuma’s allies, costing the nation dearly – with no discernible action being taken against the transgressors. The dramas at the SABC under the leadership of Communications Minister Faith Muthambi, and the social grants disaster – with Social Development Minister Bathabile Dlamini in the firing line – are a case in point. Not to mention the unthinkable R200 million cash heist at Africa’s largest and busiest airport, OR Tambo, earlier this month. How we can navigate South Africa out of this embarrassing mess without holding the ministers in question accountable for their fumblings, is hard to fathom.

PRICE REMAINS CRUCIAL VARIABLE

The question is: what are investors to make of these and other high-profile events dominating the news globally as well as on our own shores? Alwyn told our clients that although it is challenging to remain unemotional when being bombarded with negative news flow – sometimes even fake news – it would be decidedly unwise to make investment calls based on the soap operas that play out on our screens daily.

It’s not just about the macro events themselves, it’s also about the reliability of the sources that report on or attempt to predict them. News media often disseminate contradictory messages regarding the same event. As for the reliability of pollsters – even the most highly regarded of them got the outcome of both Brexit and the US election horribly wrong. Market reaction to macro events is also often highly unpredictable. For example, markets were expected to tank in the wake of a Trump election, but what happened? The equity price performance the week after the vote was the strongest it had been since 2014. In fact, since Trump became president, the US market has gone up by around 11%.

The bottom line is that basing investment decisions on the happenings hitting the news headlines would be ill advised. We naturally need to take into consideration the impact of such events on such factors as economic growth, interest rates and currency fluctuations. But at SPW, prices across asset classes will always be the most important variable we analyse when we put together a portfolio. Of course, it’s often the case that an asset class or even an individual share may only be cheap when the news flow around it is negative, which makes it challenging to convince or sell the investment decision to our clients.

Investors have a natural tendency to associate good investment opportunities with a positive growth story. It will therefore always be testing for clients to ‘buy’ into attractive investment opportunities, as it rarely happens that the market offers ‘perceived’ good quality opportunities at cheap prices. As professional investors, our challenge is different. Markets can be efficient for sustained periods – periods where investors price financial assets correctly – and it can be quite difficult to uncover mispriced investment opportunities. We need emotion in the financial markets to dislocate market prices from the intrinsic value of the underlying asset.

UNCERTAINTY WILL REMAIN

We heard from Alwyn that for the remainder of 2017, uncertainty on the local front will continue as we approach the ANC leadership T-junction at the end of the year, and our volatile currency may well respond to what will without doubt be a highly charged political environment. Economic growth is likely to be positive, but pedestrian. If the rand behaves, inflation should return to its 3–6% target band, which may lead to a cut in interest rates.

On the equity front, SPW said in January 2014 it was unlikely that the equity market would deliver double-digit returns over the following three years. The reason was simply that the market was too expensive. In fact, over the period in question the equity market moved largely sideways – the total return over the past three years was 6% per annum.

Alwyn told investors his team was more optimistic for the year ahead, however – the South African market should give a return of around 7% per annum. The reported earnings multiple of the All Share Index overstates the valuation of South African shares. Adjusting the numbers for an earnings recovery would suggest we can expect better performance from local shares compared to the previous three years. This view is also consistent with the number of individual shares we can pick that offer enough upside to compensate investors for the risk they take to invest in this asset class.

THE LAST WORD

Geo-political soap operas will always be part and parcel of our daily lives. Alwyn emphasised that even though the hype and noise around such macro events can negatively impact investor sentiment, it’s important to remember that from an investment point of view, they can provide real opportunities to buy attractively priced assets and sell expensive ones. SPW will continue to keep a close watch on these events as they unfold – while remaining committed to our long-term investment philosophy and process, and seeking out these