By Peter Armitage, Anchor Capital CEO/Liam Hechter, Anchor Fund Management
Recent weeks have been dominated by investors asking us where the best investment opportunities are in the aftermath of the global market collapse. Below, we review the asset classes across major geographies, with a focus on equities.
There are a few principles which we apply and assumptions that we make in our assessment of global and local assets. First, we assume that the world will revert to normality, although we have no idea when this will happen. At Berkshire Hathaway’s annual general meeting on Saturday (2 May), billionaire investor and Berkshire CEO Warren Buffett referred to the current period of volatility as “an interruption of growth”. The world will revert to growth. However, we are actively avoiding those assets where a longer-than-expected reversion to normality can materially and permanently damage the business. We are also avoiding areas of high risk – there is no need to assume a big risk when investment opportunities abound. There is also great merit in being patient – if you have money to invest you have time on your hands. We are not getting overly anxious when markets decline – this presents opportunities but be prepared to act. We are not getting FOMO when markets rise, and we are not fully invested – volatility will prevail for some time to come. So, also be prepared to sit on your hands, when necessary.
From a global perspective, first we highlight that low-risk assets generate no, or even a negative, return. Global developed market (DM) bond rates are basically at zero to negative and cash in the bank erodes in nominal terms. If you do not allocate some cash to riskier assets (such as property and equities), your wealth will erode in real terms. This scenario will prevail for a long time to come and interest rates simply cannot rise.
So, when and how do you invest in equities and property globally?
The first point to make is that the change in environment has impacted sectors and companies very differently – this is not a time for index investment. Oil, cars, pigs and sugar (for example) are in a big surplus so, while some companies have seen their turnover head to zero, the environment has been very positive for others. Amazon’s 1Q20 revenue, for example, was up a remarkable 26% YoY.
Nevertheless, some caution is warranted in global equity investment. There will be a lot of money to be made in these conditions, but timing is important. March 2020 was one of the worst months ever on global markets, but April saw a big bounce back – the best in the past 33 years. The bottom line is that, YTD, the MSCI World Index is down by 12% up to the end of April (with the S&P 500 index down only 9% YTD), which many would consider a far better-than-expected outcome, after the height of the novel coronavirus (CV-19) fears a month or two ago. We believe global equity markets started the year in fully valued territory and, at an index level, with prospects now far worse, markets as a whole are certainly not in value territory. Earnings in 2020 will be under immense pressure and 2021 looks uncertain. Great businesses will rebound to normality in 2021, but some of this is already factored into share prices.
Everyone we speak to both in South Africa (SA) and in the UK have been caught off guard, with the overwhelming majority of those people expecting equities to go lower from here. We note the following:
- “no one” is buying the bear market rally.
- US Federal Reserve (Fed) Chair Jerome Powell is pouring cold water on the hopes of a V-shaped recovery by stating that there is “… considerable risks to the economic outlook over the medium term.”
- 30mn people in the US are now “unemployed”.
So, how do we play global equity markets?
- Do not sell your long-term growth companies.
- In our funds we remain focussed on buying great companies at good prices and these opportunities are presenting themselves. We are excited by these opportunities and we await further pullbacks to increase our exposure.
- Certain sectors of the market will benefit from the events of the past two months and their long-term drivers and trends will be strengthened.
- Among our top holdings are: The Walt Disney Company, Yum! Brands, Nike, Prudential, Unilever, Admiral Group, ICICI Bank, GlaxoSmithKline, Amazon, Ping An Insurance, Johnson & Johnson, PayPal, Royal Dutch Shell and Alphabet.
A recovery portfolio
There are numerous share-specific opportunities which present themselves with the prospects of their share prices rising by 25%-50% in the next 12-18 months. Anchor has been running a “Recovery Portfolio”, which adds to, instead of replacing, a core long-term growth portfolio. The recovery portfolio is dominated by high-quality companies with great track records whose share prices have been hammered. Among these are: JP Morgan, Hasbro, Starbucks, McDonald’s, Paychex, Stryker, Sysco, Leggett & Platt and Ulta Beauty.
So, in global equity markets, there are some great individual opportunities, but our base-case view is that better opportunities might still present themselves and we want to make sure we have cash available to take advantage of these.
Global property is an interesting equation. Many tenants are not paying rent (especially in retail) and people are questioning whether the same amount of office space will be required after the lockdown experience. Global listed property shares have acted similarly to global equities and are down around 20%. The issue with property companies is that, generally, high levels of gearing mean that prolonged periods of reduced turnover can have a significant negative impact on net asset value (NAV) per share. Diversified listed property companies might well be a good way to play a recovery, but it should be restricted to quality plays.
Anchor has significant intellectual capital in the property space, and we are very excited about property over the next few years, especially given what is happening to capital prices. In the physical property space, there is blood on the streets, and it will get worse. Yet property has a powerful role to play in a diversified portfolio – strong, predictable, compounding and growing cash flows are available with the right tenant and leases. While listed shares might be a good way to play the recovery, we believe the direct market will be particularly attractive. The Anchor Tenant team is identifying such opportunities and will present global and local opportunities to investors over the coming months.
Moving to the local market …
SA is in a very different space to developed markets (DMs) where investors can earn a very attractive real return by investing in income and bond products. This means one can be even more patient with equity investment.
The SA market, as measured by the Capped Swix Index, bounced back by 14% in April and for the year to end April the index is down 16%. The direction in SA markets is likely to follow global markets and the rand is expected to weaken if global markets weaken and vice versa. When the world is more comfortable that normality will return in a reasonable timeframe, emerging markets (EMs) are likely to outperform DMs and the rand has the potential to recover materially. It is important to look below the index level and understand the non-SA Inc. shares that have recovered, as opposed to the SA shares. This is not surprising, as the price of many of these shares is set internationally and they have been dragged higher by their international strings.
The SA economy is only one part of the equation
It is vital to remember that, when we talk about the SA market, there is a portion that is sensitive to SA economics and a portion that is not impacted (consider Naspers, British American Tobacco [BTI], Richemont, BHP Billiton, Quilter etc.). In our equity fund, only 26% of our holdings are sensitive to the SA recovery and, despite SA’s poor short-term outlook, we have retained these because they are trading at once-in-a-decade valuations. SA banks and insurance companies are strong, and it appears that more than the worst case is already factored into many of these companies’ share prices.
MTN is an example of a share which we believe has more than 50% upside potential. Mobile telecommunications has been strong sector internationally this year and Vodacom is up for the year. MTN has fallen sharply, largely because of its Nigerian exposure (27% of profits). This contribution will fall, but we still expect it to be positive, and Nigeria is now being valued at zero in the MTN share price
The past month on the JSE was characterised by extreme volatility in those sectors with the highest degrees of operational risk brought on by CV-19 (read SA cyclicals), which, through their volatility continued to disappoint. The winners were more of the same from those sectors that have provided much of the performance contribution of the index over the past 18 months:
- Naspers/Prosus (a 2% contribution to the index);
- PGM (2.2%);
- Gold (2%); and
- British American Tobacco (1%).
While we focus on long-term investment in our philosophy, the current volatility and pricing of shares is presenting us with shorter-term opportunities.
In SA equity, our actions have been to increase the defensiveness of the portfolio. This is done by reducing our exposure to those companies with weak balance sheets, which are not yet fully reflected in the share price, and those businesses which face immediate threats to their existence and, where we can, by increasing our exposure to those leading franchises that should emerge from this crisis in a better shape – or at least where we are confident that they will emerge. An interesting observation globally in the March sell-off and the subsequent April rebound was that value tended to underperform growth. As part of our strategy, we think this multi-year growth trend of outperforming value is likely to persist, although we do not manage factors that simplistically at a portfolio level. In the last few sessions in April, we started to see some buying coming in for those names that had been severely sold off over the past six weeks, the more cyclical sectors, with growth underperforming.
Anchor’s buys and sells in April
In the Anchor BCI Equity Fund we were net sellers of The Foschini Group, Nedbank, Bidvest, Home Depot and Discovery. We were net buyers of Growthpoint, FirstRand, Old Mutual, Quilter Plc and Sibanye Stillwater.
The underperformance of the SA economy has resulted in a continued narrowing of the local investible universe, with the index becoming increasingly concentrated to a small number of large caps, mostly exporter/rand-hedge type stocks. In the short term, it is unlikely that this trend will break. However, it is likely that, over the medium term, the underperformance of domestic companies will reach an inflection point and they will return to growth once more – its human nature to extrapolate a negative trend into perpetuity, but it seldom works out that way.
As we look across global markets it is interesting to consider some EMs:
- SA (like India), could probably loosen the grip on its lockdown measures in order to save a vulnerable economy. The second-order impacts of the continued lockdown will likely be far worse than the damage caused by the virus itself. We expect positive surprises on this front, with the lockdown likely being softened to allow more businesses to open.
- China: We expect China to keep chugging along, despite the structure of its economy being very different to 2008/2009, so we anticipate the policy response needed to reflect that. Looser monetary conditions should be front and centre. However, the relationship with its biggest trading partner (the US) is rapidly deteriorating and this trend is unlikely to stop anytime soon.
- Brazil: As a country this is not in a great place. Going into the pandemic, Brazil was the big reform story of 2020. However, that has unravelled in dramatic fashion, with political and social unrest due to the country’s right-wing President Jair Bolsonaro’s handling of the crisis. The oil price crashing is also not helping Brazil’s fiscal situation
- Russia will be ok. Going into the oil market collapse the country had been building reserves for all of 5 years. Russia also has no external debt and is running twin surpluses. It is difficult to find a stronger balance sheet from a major economy. The oil price collapse is not good for the country as its biggest export commodity, so Russia will go into a recession but we note that the government has more than enough money at its disposal to stimulate fiscally ($500bn in excess reserves for a start). And, we believe that the oil market will eventually rebalance and find a level higher than where it is now.
- India also has significant social unrest due to the government’s handling of the virus. Like SA, the criticism has been directed at the economic sacrifice brought about by government’s lockdown measures. In our view, it will suffer a recession this year, but India’s banks are in far better shape than a few years ago.
Above all else we need to remember that the world will reopen, life will get back to some form of normality, Super Rugby will return, everything will be OK – the world is just going to have to figure out how to cope with all the extra debt.