During the last quarter of 2017, in the run-up to the ANC’s elective conference in December, prospects weren’t looking too rosy for two industries traditionally closely linked to changes in investor sentiment: banking and retail. This was partly due to harsh economic realities on the ground – South Africa appeared to have missed the boat in the synchronised global economic upswing (global growth notched around 3% during 2017, compared to an uninspiring 1.3% locally) and investors generally took a dim view on these two sectors.
The picture in the retail sector was particularly gloomy – from August 2016 to November 2017, the JSE General Retailers Index declined by around 26%. In a pedestrian growth environment, foreign investors were starting to doubt the normally positive South African consumer story – their misgivings augmented by a local currency under pressure following credit downgrades by more than one rating agency.
Whereas the slump in the retail sector was off a high base in August 2016, however, the bank share price performance – always a good barometer of investor perception of the health of the financial economy – plodded along sideways throughout 2017 until almost the end of the year. From January to November, the JSE Banks Index was effectively flat.
A WAVE OF RAMAPHORIA
Enter the man promising to usher in a ‘new dawn’ for South Africa – our new president, Cyril Ramaphosa. Riding high on a wave of ‘Ramaphoria’, both the retail and the banking sectors saw a massive recovery in share price performance. Both indices surged by around 40% between December 2017 and March 2018. In December alone, the banking sector recorded a return of 19%.
Unfortunately, these impressive gains had little to do with changes in consumer behaviour. They reflected only the prevailing sentiment of investors which, in our view, was a clear case of overexcitement based on the media narrative of Ramaphosa as the ‘saviour’ of South Africa in the post-Zuma era.
Indeed, as Ramaphoria started to wane by the end of the first quarter, so did the indices of the two sectors in question. Retail shares have gone down by around 15% in the two months since the start of April, and are now at the same levels as around a year ago. The banking sector has also seen a decline of just over 15% since March this year.
The very disappointing economic growth numbers released early in June served to confirm our view that it will take time for positive sentiment to spill over into improved economic performance. Both banks and retailers came under severe pressure on the release of these numbers as it dawned on investors that the business environment remains tough in both these sectors.
PIE IN THE SKY?
How did this happen? Were the marked retail and banking share gains all just pie in the sky? In our view, it was more a case of reality setting in as investors woke up to the fact that improved sentiment hasn’t translated into better operational conditions, including consumer spend. In the retail sector, several of the big guns – including Massmart, Steinhoff Africa Retail (STAR), Pick n Pay and Shoprite – reported lacklustre results, a clear indication that the initial elation around South Africa’s new leadership has not led to a groundswell of more positive activity for the retailers.
Of course for consumers to reach deeper into their wallets, they need to be both willing and able to do so. From a macro perspective, we’ve indeed seen consumer confidence picking up, which may partly explain the initial market optimism. However, there’s been little improvement in ability to buy – which depends on greater job creation, income growth, and limited increases in non-discretionary spending. We haven’t seen significant evidence of any of these. Income growth has been positive, but slow, and VAT and petrol price hikes have further eroded South Africans’ purchasing power.
MORE REALISTIC VALUATIONS
In the banking sector, the almost 40% upswing was also invariably a case of market over-optimism, resulting in a retreat to more realistic valuations. It should be said, however, that from a valuation perspective, the over-extension wasn’t quite as pronounced as that of the retail index, since the starting point for recovery was significantly lower.
It’s important to note that movements in the banking index are usually closely correlated to the ups and downs of our currency. At the start of November 2017, the rand was trading at R14.46 to the US dollar. By end-December it strengthened to R12.37, followed by a further move to R11.55 by end-February in the wake of the presidential election. Since then, however, our volatile currency has weakened again – at end-March we were back trading at R12.69 to the US dollar.
One shouldn’t lose sight here of the impact of the sell-off in emerging markets. Our banking share price pull-back is also in sympathy with slipping emerging markets currencies, as uneasy investors fear geo-political issues will affect the financial system globally.
In general however, the decline in the banking sector since March this year isn’t nearly as pronounced as that of retail stocks following the release of their results. Despite the 15% slump, banking is still one of the few sectors recording a positive return so far this year. In a sector outlook released in February, rating agency Standard & Poor’s (S&P) stated that rated South African banks were stable for the first time since 2013, and had ‘found a balance between weak economic growth and low investor and household confidence’.
IMPACT ON PORTFOLIOS
What does all this mean for investors, and what are the implications for portfolio management? At Sanlam Private Wealth, despite the 26% drop in the retail index over a period of 15 months, we saw these shares as being still too expensive. When the rally started in December 2017, we held that it was simply unsustainable and based on unrealistic expectations – a view that has now been validated by the market’s subsequent re-valuation of these shares.
It should be noted that we do have some exposure to the retail sector – we hold both Woolworths and STAR in our portfolios. Both these companies have substantial foreign operations, and are therefore less exposed to the vagaries of our local economic cycle.
In the banking sector, we were comfortable with our existing holdings despite their underperformance throughout most of last year. In our view, these stocks were already priced for a negative outcome in the ANC’s December leadership elections (ie a Zuma-faction victory). There was thus significant upside potential, which was indeed realised when Ramaphosa emerged the victor and the banks rerated. We used the opportunity to take profits at the time by selling some of the Standard Bank shares in our portfolios.
THE CONTRARIAN ROUTE
The movements in the retail and banking sectors over the past few months have clearly demonstrated the ‘disconnect’ that sometimes exists between investor sentiment and market realities – and often provides the biggest opportunities for active portfolio managers. Significant changes in such sentiment can result in overly expensive or cheap valuations of shares, and we can use such periods of extremes to buy and sell stocks to benefit our clients’ portfolios. At Sanlam Private Wealth, we’ve demonstrated that we’re quite prepared to take the contrarian route and make use of these opportunities when the popular view is exactly the opposite.
