Growing and preserving wealth

amid uncertainty

In August, the US stock market recorded its longest ever bull run, the S&P500 almost quadrupling since the 2008/09 financial crisis. What happens when the global growth story, which is already looking long in the tooth, starts to wane? How are we at SPW positioning our portfolios in response?

Pieter Fourie, Head of Global Equities: It’s important to note that a bull market is always a combination of earnings growth, and then a rerating of stocks to more expensive levels – a very different dynamic to that in South Africa, where many stocks have derated. Even though it’s a momentum-driven market at the moment, we remain value investors and we keep rotating our global equity portfolio away from overvalued parts of the market.

We have 150 names on our watch list. When a stock’s price-earnings (P/E) ratio moves from around 13 to 23 (or 24 in the case of Pernod Ricard and Moody’s Corporation, for example), we’re more cautious on the ability of even a high-quality company to outperform the market, and we may sell. We might then look at businesses such as Facebook and Sage Corporation, which are both down significantly from recent highs. Facebook is down for the year and has underperformed by 20% over the past year versus its other competitors in the Nasdaq index, but it’s a business with strong secular tailwinds. This is what value investing is all about – buying great growth businesses at the right price and making sure we stay away from businesses that are overvalued.

Our global equity portfolio is now on 17.8 times forward earnings, with a 36% return on equity. With some very attractive, high-quality businesses, we’re comfortable that we’re staying away from overvalued areas of the market – especially those exposed to trade war issues in Asia and emerging markets, where imbalances are showing up in some terrible performances for currencies and stocks.

I want to state here that the fundamentals of many US companies remain terrific. The management teams ‘get’ what drives long-term shareholder returns – they keep enhancing the economic moat of their businesses without sacrificing growth or attractive returns on capital. Warren Buffett has called the US the best emerging market in the world. Investors wanting to write off the US do so at their own peril.

Speaking of emerging markets, we’ve witnessed significant turbulence in these economies, with some referring to an emerging market crisis. Might this present buying opportunities from a global asset allocation point of view, or are there real, long-term headwinds in these markets?

Alwyn van der Merwe, Director of Investments: Emerging markets are a diverse group, so it’s always challenging to make general observations about them. However, from an investment perspective, there have been outflows from the emerging markets complex as a whole over the past eight months, following events in Turkey and Argentina.

Valuations in the complex are starting to look interesting, and there are emerging market assets one could buy at great prices. But we have to get the timing right, and in my view, it’s still a risky sector. In our unconstrained, flexible portfolio, we invested in an emerging market fund around two years ago, but we trimmed our position four months ago. The intention is to increase exposure again, but we believe it’s too early to pull the trigger. Over the short term, we remain cautious. Over the next five to 10 years, however, the positive surprise may well come from the emerging markets.

There’s a general perception that if the US dollar is strong, it’s bad for emerging markets – their currencies struggle, inflation rises, interest rates go up and it’s not conducive to economic growth. Although the US economy is growing, it’s struggling with both a fiscal as well as a trade deficit. I fail to see how the dollar can remain sustainably strong with this twin deficit. If the tide goes out for the dollar, emerging markets may well come back into favour.

What is likely to be the impact on global growth and markets of US president Donald Trump’s ongoing trade war with China and other countries?

Alwyn: From a top-down perspective, Trump’s approval of a list of tariffs on US$50 billion of imports from China is likely to add around 15 basis points (bps) to the inflation rate in the US. From an investment perspective, will it end the upcycle in economic activity? Looking only at the direct implications, it’ll undoubtedly have a negative effect on the growth rates of both the US and China. The initial indications are that it may shave off between 0.2% and 0.3% of these economies respectively, which is unlikely to bring current global growth to a standstill.

The indirect impact is harder to quantify. Over time, Trump’s trade war will have a negative effect on business confidence in the economy, especially around investment decisions. Where companies are uncertain about trade relationships, they’re likely to postpone new capital expenditure.

See our recent article on the escalating trade battle and what investors are to make of it.

In an advanced economic cycle, what are SPW’s views on global asset allocation?

Alwyn: When we construct a multi-asset class or balanced portfolio, we combine different asset classes in such a way as to balance risk versus potential return. Global equities, and US equities in particular, are as an asset class starting to look expensive relative to their own history, so we’ve downscaled our expectations for the asset class accordingly. This certainly doesn’t mean we’re expecting a crash or a collapse, but when valuations are high, prospective returns do come off a bit.

One can also look at the prices of asset classes relative to each other. Equities relative to bonds in the US are not that unattractive. However, we acknowledge the fact that they’re a bit elevated, so we’ve upped the cash holdings in our portfolios, downscaled the equity exposure, and hold minimal global bonds given the low returns they currently offer.

In South Africa, as a result of the equity market moving sideways, value opportunities are now emerging, so we’re starting to put our buying cap on. With regard to local bonds – if you’re worried about the government’s ability to repay its debt, then perhaps a 9% return on bonds isn’t good enough. So we’re underweight in this asset class. We hold fixed-interest investments in short-term paper, and we’ve achieved a decent return for that.

Closer to home, a major driver of investor uncertainty is lack of clarity around expropriation of land without compensation, and the proposed amendment to section 25 of the Constitution. What is the potential effect on investments?

Alwyn: The problem is that if you listen to the politicians, the range of views and comments on this matter is quite wide, which is causing huge uncertainty. Even though President Cyril Ramaphosa has said he doesn’t want to put food security at risk or hurt our economic growth rate, the latter is a function of a number of aspects – policy certainty, which is currently lacking, being one of them.

An important event took place a few weeks ago – the engagement between Ramaphosa, Deputy President David Mabuza, AgriSA and other agricultural organisations across the spectrum, which commentator Max du Preez called a ‘Codesa event’. So at least South Africans are talking about this important issue. We do seem to have a track record in this country of sorting out our problems without foreign mediation, albeit often at the point of crisis.

See the articles by Renier de Bruyn, Investment Analyst, on the impact of land reform on the banking sector,and Elmien du Plessis, Associate Professor in Law at North-West University, on the main issues around expropriation without compensation.

We’ve had a number of questions on Naspers, in particular Tencent. Investors are concerned about the Chinese market and its potentially negative effect on Tencent.

Pieter: We all knew the second quarter would be tough for Tencent and that the company’s growth rates weren’t sustainable, especially for its mobile gaming side. But we also know it still has massive levers to pull in terms of online advertising growth in particular, as well as cloud-based solutions.

At the moment, Tencent is trading below 20 times its earnings one year forward, which historically has been a good entry point. Given the uncertainty and the short-term negativity around Tencent, we’ll now relook the fundamentals to confirm those cloud-based opportunities. We still think there is upside.

Then there’s the announcement last week by Naspers that it will be disinvesting from MultiChoice and listing it separately on the JSE.

Alwyn: Naspers management was rather unsympathetic to the views of investors around a year ago when we suggested they should engage in activities to unlock the 40% discount to the share’s underlying value. Now they’ve said they intend unbundling and listing the MultiChoice business early in 2019. The value we’ve put on MultiChoice is around R100-110 billion, about 4% of the total value of Naspers. The market immediately responded positively – the share price increased, indicating that market participants in general shared our view.

In our view, the Naspers decision sends two positive signals about the group. First, management is prepared to act in order to unlock the discount. Second, the rest of the business can stand firmly on its own, without MultiChoice. Traditionally, MultiChoice was the cash cow of the Naspers businesses, which were still cash ‘consumers’ given where they found themselves in their development cycle. By disinvesting from MultiChoice, Naspers management is clearly confident the group’s other businesses can manage without their cash cow.

MTN can’t seem to stay out of the news – is it currently a buy or a sell? Can the telecom operator recover?

There were several questions from clients around SPW’s views on MTN – we’ve addressed these in a separate article.

With so much local uncertainty, investors are increasingly seeking ‘harbours of safety’ to park their hard-earned assets. What are the issues that need to be considered in foreign jurisdictions?

Anton Maskowitz of SPW’s Fiduciary and Tax team: With relaxed exchange controls, it’s relatively easy to move capital out of South Africa these days. You can buy property in many countries as a non-resident, but it’s important to remember there will generally be certain tax liabilities in those countries, and also in South Africa if you’re resident here.

There are also considerations on death. If you have fixed property in a common law country (in which the British legal system applies), forced heirship rules don’t apply. So you can leave everything to the SPCA, for example, should you wish – as is also the case in South Africa. In a civil law regime (Roman Dutch law), which applies in many countries east of the UK, as well as Mauritius, you won’t have the same freedom of testation – your fixed assets will typically automatically vest in your children. It’s therefore crucial that your South African will takes into account legislation applicable to your offshore assets.

One reads a lot these days about promises of ‘golden visas’ – residence permits or passports of foreign countries (mainly in Europe) in exchange for investments.

Anton: We deal with this sort of thing quite regularly – people with enough money can arguably ‘buy’ residency almost anywhere in the world. The most common schemes are those of Mauritius, Portugal, Spain, Cyprus and Malta. However, in most countries, you can’t buy nationality at the outset.

In Portugal, for example, you’ll initially only get a residency visa and the right of abode there, but you’ll still retain your South African passport. The Portuguese scheme is often referred to as the ‘Portuguese golden passport’, but this is a contradiction in terms. If you want to acquire Portuguese citizenship, you’ll still need to go through the prescribed residence period and will only be eligible for citizenship after being a resident for five years. You’ll also need to be careful you don’t inadvertently meet the local requirements for becoming a tax resident in that country, which means you may be liable for tax in both South Africa and in your new country of residence.

There are, however, islands such as St Kitts and Nevis in the Caribbean, which have substantially lowered their nationality requirements, and you can acquire nationality at the outset. If you perhaps want to call yourself a Kittitian, that is!

What’s the most important message for our clients amid all this uncertainty?

Alwyn: As I’ve mentioned in an earlier note to clients, if you’re not invested in equities when the action happens, you’ll miss out on the tremendous opportunities that equity markets provide. Periods of strong performance often follow periods of uncertainty or market turmoil. The fact is that since 1960, there has never been a rolling five- or 10-year period in which equities delivered a negative return.

Uncertainty has always been part of the investment environment. What makes it more cumbersome this time round is the level of interference from politicians both locally and globally. If market forces on which investment analysts depend don’t unfold quite as expected, this increases investment risk. I’m confident, however, that the laws of finance will eventually prevail, trump the ‘noise’ as they’ve always done, and reward investors patient enough to stay the course over time.