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Mark Ingham: Here’s how to play the JSE after Zuma’s “economic sabotage”

Independent investment analyst Mark Ingham delivers some sage advice in this special podcast to assess what JSE investors should do after South Africa’s #Pravingate asset price plunge. The interest rate sensitive stock lost a staggering R188bn in market value in the two weeks to last Friday. In the past few days, they recovered fractionally raising the question of whether the selloff was an exaggeration and hence a buying opportunity, or a warning of worse to come – whether the uptick in the last few days is a dead cat bounce or the start of something exciting. As always, Ingham offers some savvy advice. – Alec Hogg

This special podcast is brought to you by Easy Equities and independent Investment Analyst, Mark Ingham joins us now from Johannesburg. Mark, I pulled some numbers out on the interest rate sensitive stocks for their performance from before the day that Pravin Gordhan was pulled back from London to the end of last week (in other words, a two-week period) and it seems as though Pravingate, as it’s now being described is almost as bad as Nenegate.

Yes, Alec, I think there’s some merit in that argument. I think if you go back to the events of December 2015, the magnitude of that was such that I think people were quite taken aback that such a decision could have been taken without heed for the ramifications. At that point, a degree of sanity did prevail and business and organised labour and other interested parties were in a position to persuade the President as to the error of his ways. Therefore, we did come back from the brink. I think what was missing this time is the fact that the lines of communication between business and labour and other interested parties in the union buildings has all but been severed and I think given unfolding developments in the last year or so from a politics point of view, it seemed that all caution was thrown to the wind and the end result is what the end result was. I see that simply as economic sabotage.

Well, it’s not economic sabotage, the investments of pensioners, of anybody who happens to hold any shares on the JSE, particularly in interest rate sensitive stocks have taken a terrible knock. The number I got to, and it’s quite detailed, the calculations, R188bn in the two-week period with the biggest being the two big stocks, FirstRand and Standard Bank, which between them lost almost R80bn of that. We’ve seen a slight recovery this week, only slight, but is that suggesting that maybe once again, the market just overreacted?

You know, Alec, I’ve been on record, and I think you and I have chatted about this before, that I tend to say to people, given the fact that interest rate stocks are treading on a bed of nitroglycerine in effect because of the toxic politics, these are stocks that you would want to be very cautiously exposed to, I think particularly when you’re transacting in contacts or difference, the volatility can be very damaging to your pocketbook. I’ve felt too, that we’ve almost been too quiet the last few weeks and months. It’s been almost this phony war, if you will and I felt that it at some point would change and indeed it did. In fact, I think the result was probably worse than many would have actually anticipated, given where we are at the moment.  So, I don’t think, per your question that the market has necessarily overreacted.  

There has been a certain clawback if you will, in the last day or so and I think that’s partly to do with sentiment and also the vigorous response from civil society in pushing back against what we’ve observed and as with some of these stocks you’re seeing at the moment, a slight pullback, but I think the implications of what’s happened in the last couple of weeks or so, has further to move and therefore, I think there is the potential still for weakness to re-emerge, also potentially, I think Alec, for the long bonds, which I’ve watched quite carefully, to also perhaps price themselves rather weaker than we’re seeing at the moment. I think there is an argument depending on how fund managers allocate funds to South Africa for long rates to possibly edge up further.

Pravin Gordhan, South Africa’s finance minister, center, arrives at the North Gauteng High Court for a hearing in Pretoria, South Africa, on Tuesday, March 28, 2017. South African President Jacob Zuma, 74, ordered Gordhan to cancel meetings with investors in the U.K. and the U.S. and return home on Monday, a day after he had flown to London to begin the week-long roadshow. Photographer: Waldo Swiegers/Bloomberg

You mentioned earlier that you see this as economic sabotage, is that a view that is widely held in the investment community?

Alec, I can’t speak necessarily for colleagues, but I do think that there has been grave concern, not just in business with CEO’s, but I think in the broader society too and the implications of what has happened do have real economic effects. It’s been difficult enough for businesses to budget properly, given the unfolding drama that we are seeing and it doesn’t matter which business you deal with, all of them are struggling with the difficulties of the political setup that we have at the moment and that’s negative for job creation, it’s negative for investment and all these good things. So, there is a real economic impact and in addition to that there is an impact in the financial markets, all of which ultimately have the effect of filtering through to all our lives. There is no one who is unaffected by what we’re experiencing at the moment.

When you have a look at the table of the stocks that have been affected over the last couple of weeks (as mentioned, FirstRand and Standard Bank have taken the biggest hits because they are the biggest capitalised stocks), but it is interesting to see that there has been relatively little change to the share price of Investec, on the context that Investec Ltd. down 2% in its share price, FirstRand down 15%. Why would that be?

It’s a very good point that you raise. A substantial proportion of our stock market is not necessarily reflective of RSA Inc. and therefore, the economy of South Africa. The stocks that you’ve cited, that have been clouted the worst, such as FirstRand and Standard and so forth are very much linked into the South African economy. Therefore, we see the effect on pricing far more apparent from a negative point of view in stocks that are very dependent on the domestic economy for their growth and so forth and also given the fact that the stocks that we’ve just mentioned are very much linked into the price of money in the local economy and how investor sentiment plays out, they will always get hit the worst.

We saw this in December 2015 and we’ve seen exactly the same happen now. Companies are shielded to a certain extent from that because of the diversity of their earning stream, much of which would be increasingly outside of South Africa, you’ve seen the impact far less and so with the Rand having weakened, there is a corresponding cushion, if you will, in the sense that there is a Rand hedge element to them.

Are FirstRand and Standard Bank oversold in the short-term, would you see a trading opportunity there given that they’ve reversed so much in the last two weeks?

Yes, we’re very much in a fluid environment at the moment and I think the advice that I’ve had for quite some time remains. From a trading point of view, I would tend to avoid these stocks or if you are taking positions in them, take intraday positions and close off your position before the end of trading because overnight developments, for instance can also impact and therefore that would affect the opening pricing too, indeed other developments around the world could affect, but more particularly domestic events. With that in mind there is scope for short-term profit taking and we’ve seen that with FirstRand, which has moved up in the last day or so from below 45, it’s now trading at 47, so there has been a slight uptick, but if you can get one or 2% on the board, Alec, you should say thank you very much and take that away.

For those with longer term holdings in the stock, you probably wouldn’t want to disturb your portfolio because there also would be longer run retirement planning aspects associated with that potentially, tax aspects. Do I see this as a buying opportunity for fresh money looking down the road, people who are prepared to buy and hold? I’m not convinced about that, Alec, and we would need to see a dramatic stabilisation of the macro environment which has deteriorated and that over and above the politics that we’ve just talked about.

We’d have to have quite a sharp change in that environment and a much better line of sight on the future before I could start to say these are offering good value for money. If we do see long bonds shoot up further, if we do see a difficulty in government rolling over dead, if there is increasing aversions, so for instance, if Moody’s come out after their route and branch review, which they’re doing at the moment, if that unfolds in the next few weeks and is negative for South Africa, you could see a number of these companies affected quite sharply on the down side.

So, it’s a very fluid and high risk situation. Just to put into context, FirstRand before Pravin Gordhan was recalled from London, was at 52.5, so it’s down to below 45, come back to 47, but still a long way from where it was pre Pravingate, if you like. Is there anything though, on the JSE that would start attracting your attention, anything that might have been oversold, or anything that, heavens, might be a beneficiary from all this volatility?

I think you would probably still look at counters that can be partly shielded from this. I think Capitec is probably the one exception in the interest-sensitive stocks. Although it was affected, we saw the stock price down to below R720 and it was over R800 at one point, that has subsequently come back to over R770 and I had put out a note recently reiterating at buy on, on that particular stock. Therefore, I think Capitec, because of its differentiated nature, probably has a better capacity to ride through the situation. Moreover, I think its pricing as a growth stock rather than as you would see with the Big Four banks, is such that was one opportunity that I thought one could take advantage of. At these levels, having come back following on from the noise of the last couple of weeks, I wouldn’t be pushing it at these levels. Similarly, we’ve seen a very good response from Naspers, more currency related and external factors.

I think in general, Alec, there are a number of places that you can hide on the JSE from domestic turbulence and given the depth and sophistication of South Africa’s financial market, I think it sends the appropriate signals, certainly from a political point of view, that sends the right messages and mark was moved fairly quickly, but the degree to which we have foreign earnings in the mix and the growth of that, is such that I think those who are exposed in that arena have been shielded somewhat and I think as we go forward and I see it from a number of companies that I actually deal with, the degree to which I think foreign earnings will become a greater component will only accelerate with time.

Mark, at our BizNews Club London event this week, the overwhelming view was that there isn’t going to be a collapse to Zimbabwe style, but on the other hand there isn’t going to be a rejuvenation of the South African economy. Generally speaking, the view was corruption will continue, Zuma’s ex-wife will succeed him and it’s going to be very more of the same, high unemployment, low economic growth rates, how does that affect stock markets, how indeed, if you take that scenario as the one that is going to play out, would you be positioning your portfolio?

I think we are blessed with having some very high quality companies listed on the JSE and we have Mr Brian Joffe coming back to the market again soon, as you’ve seen too, so if we look at what Brian’s doing at the moment and his new business is going to be focused in South Africa, I think Brian’s on record as saying, look, you know he started Bidvest at a particularly troubling time politically and economically, so I wouldn’t necessarily be a complete doomster. I think many businesses are taking what they learn in South Africa and rolling that out successfully abroad companies like Discovery for instance, doing some very useful things, Sanlam also spreading its wings and indeed, real estate investment stops as well, Growthpoint is a good example too of a company redefined in the same boat, a company that’s spreading its wings abroad.

Nkosazana Dlamini-Zuma

So, I think we have a good mix and match of both domestically focused companies, typically banks, but a growing spread of stocks to choose from that again will shield investors from some of the domestic turbulence that we’re speaking about. We don’t quite know what’s going to happen. From the events, from the civil society reaction in the last couple of weeks it’s quite clear that people are extremely unhappy and are prepared to voice that and I think that is a very positive development that certainly sets South Africa apart. We are prepared to do what is right and so whatever the politics will be, we are fortunate to have a good, rich vein of companies to choose from. That in itself is positive and will help us maintain wealth and indeed, hopefully grow wealth over time.

Have the investment markets then completely discounted the negative scenario, the one that has been painted at events like the one that we had here in London, i.e. if there’s some unexpected positive development, Zuma resigns, an election is called breakaway in the ANC more competitive politics, something like that, that that might actually lift the South African asset prices?

Yes, I think you’re right, Alec. I think there’s been an element of discounting in the markets. Over time I think the price signals show us that. It probably hasn’t fully discounted a truly negative scenario and there are various scenarios doing the rounds, but I think the fact that the market reacts quite positively to these events as we saw yesterday where people joined forces and have one voice in protest. That does filter through to people’s sentiments and the way foreigners to look at the country. I think there are certain elements of Brazil coming through over here and we saw the markets there certainly react very positively to the politicians being held to account.

Even though the real economy hadn’t really changed much, even though the financial situation was still very troubling, markets moved quite quickly and positively and so we could see a very similar development over here, with the expectation that, given a normalisation of the political situation, rational policies being put in place by good people, I think markets will then price in recovery, South Africa opening up to the outside world, reduced corruption, all that good stuff and the ability of companies to budget properly, to grow and to look positively.

So, I think we’re in for a pretty interesting ride, Alec. We’re going to see some volatile times, but in that there is a degree of opportunity. I think one just has to be cognizant of the downside risks and hence the fact that I’ve been very cautious of those companies that are more domestically oriented and more particularly those that have a financial focus and banks are full square in that.

Mark Ingham is an Independent Investment Analyst and this special podcast was brought to you by Easy Equities.

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