The movements in stock markets over the last month have been volatile as financial markets react to the despair and hope induced by the coronavirus. There has been a rush for cash with investors pulling an unprecedented amount of money from the market as Covid-19 spreads. Biznews founder Alec Hogg touched base with Duncan Artus from Allan Gray on what can be expected in the near and longer term. He provides his views on Naspers, British American Tobacco and Sasol, which registered a 46% surge on the Johannesburg Stock today. And although he says he is not allowed to give advice, Artus has been encouraging people to ‘stick it for the long term.’ – Linda van Tilburg
Getting to the investment scenario with Allan Gray’s Duncan Artus, we have seen an uplift in the markets this week. Theoretically, looking 6 months ahead we should have semblance of normality?
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Yes. The South African stock market’s up 26% in Rand terms. We bottomed around 37,800 and we are almost back at 48,000 today. The Rand has weakened quite substantially, so the returns in dollars aren’t right. If you follow markets quite closely, some of the moves are just astounding and you can’t explain them with fundamentals. So what we’ve been saying to people is that markets go up and down and most of the trade in offshore markets has got nothing to do with fundamentals, its algorithms, ETFs, high frequency traders, leveraged traders, risk parity funds. Those things are very difficult for normal investors to understand but that’s why you’re having these huge moves. What is particularly important is a lot of South Africans are focused on the equity markets, probably because it’s easier to see. But the big dislocations we had offshore was in the credit and fixed income markets which are supposed to be lower risk assets.
They pretty much seized up at one point?
Yes. In South Africa there was a day where the bond spiked a couple of hundred basis points and we’ve hardly ever seen that before. The primary market makers – the people who buy and sell the bonds – I think there are 9 of them in South Africa. 7 of them did not want to make a market on the one day because they had so much stock put onto their own balance sheet and they have to hold capital against that and weren’t able to off-lay the bonds somewhere else. In America they had the $250bn of outflows in one week, or a month – from bond funds – because in this rush for cash people are selling what they can, not what they want. So the first things you sell are the more liquid, higher quality fixed income asset. The problem with that is more and more of your portfolio gets made up of more exotic credit instruments which there are not liquid markets for.
Now you did mention how strongly South Africa’s stock market has recovered from the very worst of almost that blow off phase. Have you taken advantage of that? Have you been able to keep your head while others have been losing theirs?
I hope so. We are not focusing too much on performance or the funds, just doing what is correct and making less mistakes than anybody else. The Reserve Bank held a call this morning where they put out the bank’s dividends, which will have to be suspended, but those that have been declared can be paid out. Nedbank all of a sudden is at 19% so now the share looks cheap. Just one thing that’s different, going back to Nenegate, we had big positions in British American Tobacco and South African Breweries. We sold those aggressively to buy the banks. We’re not doing that to the same extent this time. British American Tobacco and SAB happens to be our two biggest shares but we’re not aggressively selling them and buying loads of South Africa Inc. We’re fairly comfortable with the level of exposure we have. If this continues for another six months there are going to be a lot of casualties amongst the smaller and mid-cap companies.
What areas are you really staying away from when you say that.
Many people will have invested in some of them. I wouldn’t want to give individual names but some of these companies’ balance sheets are not that strong, however usually in a “return to normality” they would see their way through it. But now we have this virus and these businesses have no revenue for three months. The big trick here is to see which businesses have quality assets and are solvent and only facing a bit of liquidity issues, which means banks will tide them through. I can’t see a situation where South African banks want to end up earning – as an example – half the South African retail sector. These are businesses that have been around a long time and we know what their cash flows and profits are. In more normal times, we think those are the kind of businesses that will come through, however if this virus and lockdown carries on for longer, we have to think differently.
So if the president decides that after 21 days it hasn’t been long enough and that the evidence that he has, suggests it’s going to continue for 3 months. Would that put a nail through the heart of some of those companies you talk about?
Yes for sure. The economic impact of this globally has as yet to be seen. There are a lot of people, about 10m Americans, unemployed in 2 weeks, lots of people in poor and mid-west America are just being retrenched at a massive rate, and there are queues for food which haven’t been seen since the Great Depression. They are a much stronger economy than us, and if the lockdown is extended here, and the odds are pretty good, we could potentially have social unrest here. What we should do is have people tested, and those with antibodies should go back to work. If we don’t, how do we come back from this? Markets should be more sustainable if a clear exit strategy is agreed globally.
An exit strategy, meaning not everybody goes back to work but there would presumably some kind of a phased way that the economy gets running again?
Yes, also how do you travel to see your family if they were stuck in Johannesburg and you are in Cape Town? What about opening restaurants and gyms? There are so many decisions to make and one of my concerns is does South Africa have enough competent people in our government to manage this very complex process? It’s one thing telling people to go home and provide some sort of rescue, but how do you get everyone back to work? I just hope we have the necessary skills outside of the Treasury and the Reserve Bank to do that because it’s going to be very complex, even for countries much more sophisticated than ourselves.
What about quantitative easing or the injection of cash by the Reserve Bank which has been the case clearly in the United States where they already put $2tr into the economy?
I don’t think the Reserve Bank governor would be very happy with quantitative easing. I think they’re quietly buying bonds in the market to provide liquidity in the market to stop the fixed income market from freezing up. The Reserve Bank has done well relaxing capital regulations or liquidity requirements. The Reserve Bank and the Treasury are doing a good job. The irony in America of Quantitative easing was the Republicans stood up against the extreme leftists in the Democrat party, and now America’s printing money. One would think the natural outcome is massive global inflation. But so far Japan’s been printing money for 20 odd years and you know that they still have very low inflation so it’s going to be interesting to see how it all plays out. However it would make me very nervous if South Africa just starts printing money. We only have to look just north of us to see what can happen.
Your portfolio – as you mentioned earlier – your two biggest stocks are Naspers and British American Tobacco. They’ve been resilient during this period. Many of your critics point out that Sasol was your biggest shareholder. From the communication you’ve given, you did start selling Sasol but you weren’t able to sell all of it before the crisis hit. When Sasol was in the R20’s. Were you piling back in?
No. I think it’s up another 40% today. The equity is really trading like an option now, meaning the market cap got to R220bn. But the debt may be close to R190bn. We sold around 40% of our holding at higher prices.Then as it fell, we bought them back, but we changed its risk rating – meaning the debt is fairly big compared to the near-term profits – and any possible further fall in the oil and chemical prices is going to be under real pressure. And that’s what’s happened now. So is the theory of the investment case still correct? Yes it is. In a more normalised environment they will start up, they’ll produce, there goal was around $1bn. You have the normal operations profitable and it all turns around. So the theory I think was still sound. When you have an exposed balance sheet like that and you have a collapse in energy prices – that you have now – you’re pretty vulnerable.
What about the rand with the way that the rand has blown out. Has this given you an opportunity to bring some offshore cash back into South Africa, are you even thinking that way?
Yes Alec we have been doing that. Rand already moved back. We were at 19/20 and now we are at 18. In December we were at 14. I think we’ve been the weakest emerging market currency – I stand corrected – but it feels like we’ve moved too much and why is that? We have a very liquid currency and fixed income market. With the outflows from emerging markets, we are often the first people to get hit. So people can reduce their exposure to emerging markets but when we look at the yields that were being offered 2 weeks ago on South African long dated bonds over 13% but with 4% inflation and inflation may rise – as it probably will with the rand – which are attractive real yields. I think the South African dollar bond – in other words bonds the government issues in dollars – is trading at around 7.5% and America is trading just under 1%. So there’s a huge risk premium being placed on South African assets and we think that’s attractive. So we bought back a few percent of the portfolio to have cash in South Africa in case there are more opportunities in the market here, and secondly to take advantage of some of these high yields that were available in government credit.
We spoke about what you’re not buying. In other words those businesses that are highly geared that could have done okay in a good market but with Covid-19 it might be the death knell. But what are you looking at as an opportunity in this environment?
We have done research on the banks because they are very important to an economy. If something goes wrong, a lot of businesses could get into trouble. We have done detailed reports on their capital, what losses would have to be to pay their capital position, because the one sector that definitely hurt us in this fall was financials. So we owned Standard Bank, Nedbank, FirstRand through RMH, Old Mutual and Investec. These financials were by far the biggest under performers as a sector. The industrials held up because of Naspers and British American Tobacco, but financials – a lot of them were trading on three times profit – in any kind of normalised South African environment a lot of the shares could double or more. Nedbank got down to less than three times earnings and understandably so because if there were a lot of bad debts, things could go wrong in the banking sector. If they manage to survive their way through it, you know there’s a lot of value to be found.
Mr Market has been in the most depressed state that we might even see in our lifetimes. But some your customers will have panicked. What are the questions they are asking you and how do you respond?
Most asset managers in South Africa and their clients are advised clients. In other words they come through financial advisors or through platforms offered by the large companies. Those advisors – many of them – are really good at the job and basically keep investors calm. I guess what most people are asking about is why shouldn’t I just be in cash because most balanced funds and equity funds either under-performed or have produced negative returns over three years. There may be those with no income and may have to start selling their unit trusts at depressed prices to fund either a business or personal life. So a lot of the questions are more about why the level of returns have been so low and there’s a long history to show that balanced funds in South Africa are around about 5% better than inflation over the longer term. Cash normally only produces about 1% over the long term. We have been encouraging advisors to encourage their clients to hang in for the long term. One has to make the decisions that you have to make with your immediate future but try as much as possible not to sell assets at what we think are good prices from a long term point of view.
