JOHN BICCARD: Time to buy as the herd c(r)ashes out?

Every day I wake up to another article in the media imploring investors to take their money out of South Africa. Unfortunately, making money in the equity market is not as easy as reading the newspaper and looking at what is going on around you. If it were, there would be a lot more rich people out there.

The key to investing is to try to work out how much of what is in the newspapers and what is happening in the streets is in the price. Making money out of investing on information that is fully known by the market is not possible — that is why insider trading is so lucrative (and illegal).

On this basis, an investment in South African equities should at least be considered. Is there anyone on this planet who doesn’t know the litany of woes that is South Africa?

Five years ago, at the height of the “Ramaphoria” equity surge in South Africa, I argued the other way. As a result, I positioned the portfolios I manage (which include the Ninety One Value Fund) accordingly, holding almost no South Africa Inc stocks, as the market discounted a market-friendly new regime with no president Jacob Zuma at the helm.

That didn’t work out so well given the relatively high valuations paid for local stocks, together with the subsequent disappointments the country has delivered. Five years later one thing has changed: the price of local equities. And when the price changes, I change my mind.

South African equity valuations now fully discount the current reality and appear to me to be discounting load-shedding in perpetuity. The JSE all share index’s p:e of 11 is near the bottom of its long-term trading range but is an aggregated valuation measure which is distorted upwards by the high valuations of the large-cap dual-listed stocks such as Naspers and Richemont and distorted downwards by the low historic valuations of the resource stocks trading on the JSE.

In order to get a fairer reflection of the valuation being applied to South Africa Inc, we would use Nedbank as a proxy — a liquid company that is 90% exposed to the South African economy. Five years ago, as investors drank the Ramaphoria Kool-Aid, the shares traded at R300 on an exchange rate of R12 to the dollar — the valuation was a 12.5 p:e/4% dividend yield and 1.8 times book value.

Fast-forward five (disappointing) years and today the shares are trading at R200, the rand is at 18 to the dollar and investors who liked the South Africa of five years ago are down 56% in dollars on their Nedbank investment. And the valuation? Now a much more interesting 7 p:e/8% dividend yield and just 0.9 times book value. Furthermore, Nedbank is better capitalised than five years ago.

A starting yield of 8% can cover a lot of bad outcomes and we would argue that while this valuation doesn’t discount the case that South African equities become Zimbabwe or Sudan, it certainly discounts no improvement ever in South Africa’s long list of problems.

What about positioning in South African equities? An attractive valuation is one thing, but if there remains a long list of sellers, the shares may well fall for a longer time than you can stomach. Fifteen years ago, South African equities balanced funds held 63% of their assets in local equities — today it is 40%. The unit trust domestic equity category now has close to 35% offshore (from 20% five years ago) and is probably on its way to the maximum allowed 45% level.

Foreign investors are a more important gauge as they represent the marginal buyer/seller, so they are effectively outside the system and their buying and selling will determine the price to an even greater extent.

Here the positioning is even more negative, with foreign emerging-market investors now holding a one-third underweight position against their respective global emerging-market benchmarks — a position that has led to R600bn of foreign sales of JSE equities over the past five years.

Our conclusion here is that foreign selling is exhausted and local selling is 80% done. It is extremely unlikely ever to time the bottom of a market, but these statistics show how well advanced the “short” South African trade is. A concrete sign of foreign investors’ distaste for South Africa was seen in the March Sun City South African conference run by a large international investment bank — it attracted only 14 foreign institutions vs 33 before Covid.

There is an old adage in the market: “Buy on the sound of cannons, sell on the sound of trumpets.” Perhaps in our case this should be changed to: “Buy when the lights are off, sell when they come back on.” Returns from this point look asymmetrical to us — an 8% starting yield on many domestic stocks to us suggests reasonable returns even on the “muddle-through” base-case scenario in which GDP remains stagnant.

Put another way, investors exiting South African equities to take their money to offshore stock should bear in mind that they are effectively selling Nedbank to buy Microsoft — after Microsoft has outperformed Nedbank by 700% in dollars over the past five years.