Weaker dollar and rising demand bode well for SA equity market rebound
Covid-19 chaos and extraordinary volatility notwithstanding, it was gratifying that the SA equity market recovered all its losses by the end of 2020. This year started strong, with every indication that we are well positioned for further recovery.
A string of recent positive macro developments, coupled with a weaker US dollar and tight supply-and-demand dynamics in some commodities, should see equity markets continue to grind higher. A lot of liquidity is targeting equity markets and, more specifically, emerging markets such as ours, as investors seek attractive real returns.
However, we are not entirely out of the woods. The next few months could see further waves of the pandemic, with markets facing much stopping and starting, before vaccines and herd immunity help facilitate a global growth recovery from the second half of the year.
We construct the Ninety One Equity Fund using intensive fundamental research and bottom-up stock selection. We allocate capital to stocks where expected future earnings are being revised upwards, and we like to buy these at reasonable valuations. We believe what moves the share price for a particular stock is the market’s change in earnings expectations — if these are revised upwards, it drives the share price higher, and similarly, if these are revised downwards, the share is likely to underperform.
Excluding Naspers, the SA equity market offers a potential dividend yield of 4%-5%, arguably equivalent to the cash rate. Added to that, we also need to consider the earnings recovery profile of some of the stocks, which we believe to be stronger than the consensus 10% or 15% built into many models.
Accordingly, we have tilted the domestic portion of our portfolio towards a more cyclical recovery trade, with exposure across four broad sectors:
- Global cyclicals. Close to 40% of our domestic equities are allocated to global cyclicals, due to the clear tailwinds we see in this sector. Resource stocks are set to benefit from the recovery in China’s economy and tight commodity markets, coupled with improving global consumer demand. Both the large diversified miners (Anglo American and BHP Billiton) and the platinum group metals (PGM) miners are seeing positive earnings revisions as the market catches on to robust commodity pricing, driven by a global demand recovery.
We have a material allocation to PGM miners. As vehicle sales rebound, demand for platinum and palladium used in autocatalysts continues to recover. Investment into PGM production has also been lacking in recent years, leading to insufficient new supply coming to market. This means the platinum, and especially palladium and rhodium markets, should continue to stay constructive and tight.
- Local cyclicals. In the beaten-up domestic economy, some of the SA Inc stocks have seen a lot of negative revisions but are starting to bottom out, while shares continue to trade at attractive valuations. As these companies start reporting, forecasters are noting they may have been overly cautious, with some companies reporting numbers for the half-year which people thought would be their full-year earnings.
Several SA banks, for example, had to make provision for bad debts in the third quarter of 2020 when we were under stricter lockdown conditions. We believe many of those provisions are overly conservative. The recovery in retail sales, as well as collections for banks, are exceeding most expectations.
We have accordingly switched some exposure from global defensives such as British American Tobacco to local cyclicals, which now comprise about a third (34%) of the portfolio. A key consideration for inclusion is balance sheet quality. We have select positions in financials where valuations are attractive and earnings revisions have bottomed, such as Sanlam, FirstRand and Capitec, as well as retailers including TFG, Truworths and Pepkor.
- Global defensives. We have actively reduced our exposure to global defensives from about 40% in June 2020 to just over 20% of the portfolio. While we are constructive on the outlook for the rand, they will provide protection against rand weakness, should it materialise. Our holdings include Naspers and Prosus, which give you Tencent at a discount, as well as Richemont, AB InBev and Bidcorp.
- Local defensives. Our smallest allocation is to local defensives. The position has remained stable at just below 10% since the middle of 2020, as we do not believe earnings revisions relative to the price you pay for them are compelling. We have select exposure to some food retailers, such as Pick n Pay, and a moderate allocation to MTN.
Overall, we have reduced our overall offshore exposure from 30% to about 25%, in light of our constructive view on local opportunities. We believe the global stocks we hold complement the resource and SA Inc shares comprising the lion’s share of our domestic holdings.
As the recovery takes hold, we think the appealing valuations and a strong earnings recovery profile should drive attractive returns for SA equity investors over the medium term.
• Van den Berg is co-head of SA equity and multi-asset at Ninety One.
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