Quarter in review
The first quarter of 2019 saw the JSE’s All Share Index (ALSI) record the best start to the year in 12 years, gaining 8.0% over the three months to end March, despite a diverse – even disparate – set of events impacting the market.
Underlying the market’s rebound were strong gains among rand hedge and South African precious metal stocks, including British American Tobacco’s 27.4% rally, and Naspers’ 15.2% gain.
Mining giants Implats and Amplats were also among the top performing stocks in the first quarter, returning 66.3% and 36.8% respectively, owing to an increase in the platinum group metals basket prices led by palladium (+9.8%) and platinum (+6.8%).
However, despite an overall positive result, the local equity market still underperformed global markets measured in hard currency terms, with global equity up 12.2% in USD. Emerging markets performances were mixed, with Egypt up 19.3%, and Brazil and Mexico delivering returns of 7.3% and 5.8% respectively for the quarter.
Source: Cannon Asset Managers, 2019
And aside from the JSE’s handful of large-cap multinationals and the resource sector, other equity sectors generally battled to record gains.
South African-focussed industrials remained under pressure, constrained by weak economic growth, a high unemployment rate and electricity supply disruptions, amongst other factors. The financial sector then adjusted to new tempered interest rate expectations, which is a key driver for bank profitability.
Weaknesses in the local equity market mirror weaknesses in the local economy. SA’s economy has become largely consumer driven over the course of the past decade, and unfortunately, with slow economic growth, tax hikes and household indebtedness thrown into the mix, the consumer segment has become strained.
The International Monetary Fund (IMF) recently lowered SA’s projected gross domestic product (GDP) growth rate from 1.4% to 1.2% for 2019, ranking the local economy among the slowest growers in the sub-Saharan region, which is expected to grow an average of 3.5% this year.
Given the anaemic local economic environment, strategic asset allocation and effective diversification remain key to protecting capital and generating returns.
In terms of asset allocation, we remain underweight bonds and continue to favour preference shares. Regarding preference shares, the risk-return dynamics are relatively more attractive, and the asset class has proven to be less sensitive to economic weakness and political uncertainties. In addition, preference shares continue to offer investors high yields and diversification benefits, which are invaluable in volatile times.
Having been underweight property shares for several years due to high valuations, the 2018 sell-off has opened some potentially rewarding investment opportunities. The de-rating in the sector has resulted in relatively attractive yields and price-to-book valuations. However, while we have modestly increased our weighting, we remain cautious of the underlying risks in the sector and will continue to closely monitor each of these investments.
Within our equity allocation, we remain invested in good businesses at great prices. And we believe that notwithstanding the difficult local environment, there are a number of attractively valued businesses that offer good prospects:
Afrimat is a producer of aggregates, industrial minerals and commodities with branches located across South Africa. Lowering transportation costs for clients has resulted in a clear competitive advantage for the business, and the company recently released a trading update stating that the results for the 2018/19 financial year saw headline earnings per share grow between 20-30%, well-above that of its peers. Led by a strong management team and given SA’s road construction backlog, there is a strong investment case to be made.
Metair is a battery and vehicle component manufacturer with operations in various developing markets, including South Africa and Turkey, making the company an attractive rand hedge within an investment portfolio. The business is entering a new growth phase, slowly building up a track record in lithium-ion batteries to complement its lead acid business, resulting in handsome future growth prospects.
Stor-age is the largest self-storage brand in South Africa. It develops, acquires and manages high profile storage properties, with more than 30 600 tenants across its 73 properties. The local self-storage market is rapidly expanding, and is under-penetrated relative to developed economies, suggesting a good runway of growth opportunities. Storage delivers an attractive income stream with the potential for income and capital growth through increasing rentals and occupancy levels, expanding existing properties and acquiring additional self-storage properties.
Many companies with exposure to the local economy are attractively priced at present. However, the negative impact of policy uncertainty (ranging from mining and land to labour), electricity supply shortages, and other economic pressures will continue to limit growth.
Ultimately, the local equity market will only improve when the economy improves. After the elections, we can hopefully expect to see the necessary measures finally put in place to promote economic growth – although perhaps not as quickly or meaningfully as many would like.