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Weekly Market Report
17 January 2023
Catalyst for better markets.
Shares for 2023.
Global and local indicators.
By Nick Downing
At the end of last year investment strategists had locked onto three catalysts that might improve market fortunes in 2023. A faster than expected fall in inflation, an end to the war in Ukraine and third, a reopening of China’s economy from its Covid-zero policy. Inflation is easing but has a long way to go before reaching central bank target levels and may prove sticky the closer it gets to targets. Russia has scaled back its demands for regime change in Ukraine, but negotiations for a face-saving exit have yet to commence. China, however, surprised the world with the speed of its Covid policy change. Beijing is now wholly committed to beating the virus through herd immunity rather than isolation through strict lockdowns. China removed all domestic and international Covid restrictions in December.
One of the key catalysts for better equity market returns over the next 12 months is firmly in place largely explaining the year’s strong start. OAM increased portfolio equity exposure in early December and what better way to do so than via China and the Far East. On 5th December OAM added Fidelity China Special Situations PLC (FCSS) to our Global Growth portfolios and Schroder Oriental Income Fund Limited (SOI), more conservative due to its greater regional diversification and higher dividend yield, to Global Balanced and Global Defensive portfolios. Both investment companies are listed on the London Stock Exchange.
Dale Nicholls, the manager of FCSS, highlighted that market sentiment is “probably the worst I have ever seen.” As a result, China’s share prices are offering considerable value. Valuations dropped to all-time lows relative to developed markets. China’s banking sector is close to the valuations that US banks traded at during the depth of the 2008/09 Global Financial Crisis. FCSS is finding a plethora of investment opportunities, which is reflected in a relatively high gearing level, currently at around 25%. FCSS has performed well since Dale Nicholls took over as manager in April 2014 with a net asset value return of 10.6% per annum compared with 6.6% for the MSCI China index. The share trades at an attractive 10% discount to net asset value.
SOI provides conservative exposure to China’s expected recovery. The whole Far East region stands to benefit as China emerges from one of its worst years on record with the lifting of Covid restrictions, reduced regulatory threats and greater monetary and fiscal stimulus, much of it aimed at restoring confidence in the property sector. SOI is conservatively managed, targeting companies with strong balance sheets and progressive dividend policies, driving a combination of both capital growth and income returns. SOI trades at an attractive 4.7% dividend yield and has delivered a growing dividend every year since its listing in 2005. Many Asian companies are increasingly focused on dividends as a contributor to shareholder returns. Overall dividend pay-out ratios in Asia look undemanding and companies have low indebtedness. The company’s defensive characteristics are illustrated by the 2.5% increase in NAV in the financial year to 31st August 2022 compared with a 7.7% fall in the MSCI Pacific ex-Japan index.
It has been one of the worst years on record for China’s economy and its equity markets. The combination of strict Covid lockdowns, property woes and regulatory crackdowns impacted economic activity and investor sentiment. The country’s 20th Party Congress caused even more alarm among investors as President Xi Jinping cemented an unprecedented third term in office. For the first 9 months of the year, GDP grew by 3.0% on the year, and for the full year is expected to be lower still, well below the official target of 5.5%.
The lifting of Covid restrictions dented growth even further in December due to the spike in infections, hospitalisations and people staying away but according to commuter statistics and shopping mall footfall the country is past its peak and activity is rapidly returning to normal levels. Two years’ worth of pent-up household expenditure financed by precautionary savings is expected to result in a surge in consumer spending. The depressed property market is unlikely to contribute to GDP but by the same token it is no longer expected to detract from growth.
Fiscal and monetary stimulus are being directed at moderating the pace of the property market’s readjustment and reduce its burden on the broader economy. In the biggest rescue operation yet, in early December major state-owned banks announced large credit lines to solvent property developers. There has been an easing in the so-called “three red lines” policy, restrictions aimed at deleveraging the real estate market imposed since August 2020. Meanwhile, the threat of further regulatory crackdowns on the private sector, in particular tech companies, is likely to diminish as government prioritises economic growth. The chairman of the China Banking and Insurance Regulatory Commission told the official state news agency Xinhua that the crackdown on technology companies is “basically over.”
China’s GDP is unlikely to recover at the same heady pace that it did in 2021 when the nation rapidly emerged from the initial pandemic wave. That year GDP grew by 8.1%. Global export demand for China’s manufactured goods has since slowed and the property market will be neutral at best but growth of 5-6% is being projected, which should underwrite solid earnings growth and provide a boost to the entire Asia-Pacific region. According to independent research firm MRB Partners, the 12-month forward earnings estimate for the dominant consumer discretionary sector is already 12% higher than it was 6 months ago.
As well as benefitting the Asia-Pacific region China’s economic recovery will boost world GDP, reducing the risk of global recession and limiting the severity of expected recessions in the US, Europe, and UK. China is the world’s second largest economy. Some analysts have flagged the risk that China’s recovery could jeopardise the decline in inflation.
There are concerns that increased demand for imported goods in particular oil and industrial commodities could cause inflation to spike again. Although the oil price may not retreat as much as previously expected most risks to inflation are benign. The full removal of China’s supply chain disruptions should ease rather than aggravate inflationary pressures. According to independent research company Capital Economics “China will likely return to being a source of goods deflation.”
By Gielie Fourie
INTRODUCTION: 2022 was not a good year for investors on the Johannesburg Stock Exchange (JSE). The Russia-Ukraine war was responsible for much of this. The JSE was down 0.90% for the year. 2023 has started with a strong recovery with the JSE reaching an all-time high (ATH) of 79,334 on Friday 13 January 2023. Despite the ATH the JSE is still cheap when one looks at valuation ratios.
WHAT TO BUY: 2023 will be a year of investing dangerously, wrote Marc Hasenfuss, a reporter of the Financial Mail (FM) on 12 January 2023. Professional investors surveyed by the FM believe US stocks remain too expensive, which means the focus will shift to Europe, and emerging markets such as South Africa. John Biccard, portfolio manager of the Ninety One Value Fund, says the JSE remains overwhelming cheap compared with other emerging markets. “The discount of the SA market to other emerging markets is almost at a record. There is a lot of unbelievable value,” Biccard says. We look at ten share picks of local analysts.
The choice of Marc Hasenfuss is RCL Foods (RCL). RCL has a market capitalisation of R10 billion (bn). The Price Earnings (PE) ratio is 8.9x, the Dividend Yield (DY) is 4.4% and the Price-to-Book (P:B) ratio is 0.84. The metrics indicate that RCL is a little under-priced at R10.45. A planned restructuring will unlock value – RCL can be considered as a value stock. The name (RCL) reveals its history and connection to the delisted Rainbow Chicken Limited. Its restructuring process is slowly unfolding. The poultry business, the old Rainbow Chicken, has been separated into a standalone business that could get sold or listed again. RCL will then focus on its grocery brands.
The pick of the Finance Ghost (an anonymous finance journalist) is Shoprite (SHP). With a market capitalisation of R144bn, SHP is the biggest retailer in Africa. The PE ratio is 23x, the DY is 2.5% and the P:B ratio is 5.19. It is trading at R243.00 per share. SHP is trading at a high premium to its net asset value (NAV). The share is expensive. It is a growth share with plenty momentum for further growth. After Whitey Basson left SHP, the new CEO, Pieter Engelbrecht, has not put a foot wrong.
The pick of David McKay, a journalist focussing on the African mining industry, is Glencore (GLN). It is the biggest mining company in the world by 12-month trailing (TTM) revenue. GLN is a Swiss company with a secondary listing on the JSE. Its market capitalisation on the JSE is R1.5 trillion. The PE ratio is 6.6x, the DY is 3.6% and the P:B ratio is 2.14. It is trading at R113.00 per share. Although its price is up 33% over the past year, the ratios indicate that GLN is not expensive. GLN had a record financial performance in 1H 2022 – profits were up 40%, while the PE ratio is a low 6.6x. GLN mines a portfolio of minerals that includes cobalt and copper. You cannot build an electric vehicle without cobalt and copper. Glencore’s other commodities are lead, zinc, gold, silver, ferrochrome, coal, and oil. Mining companies, including GLN, have the healthiest balance sheets in two years. GLN is one of the world’s leading marketers of physical commodities. The marketing business and the diversified commodity portfolio makes GLN a defensive company. Analysts’ upside for GLN varies between 35% and 50% over the next year.
Deep-value advocate, John Biccard, points to several “jackpot” stocks that can still be bought on the JSE. Biccard’s “jackpot” stocks have two characteristics: they have PE ratios of less than seven, and they offer a dividend yield of 7.0%. He says there are several stocks trading at close to this (magnificent seven) combination. He adds: “If you buy a stock at a DY of seven, you generally make money.” His two high conviction stocks are Spar (PE 10.95x, DY 3.15%) and Sappi (PE 2.39x, DY 5.44%). PE and DY figures for bigger companies are published every week in the FM.
Independent analyst Anthony Clark’s high conviction stock is Curro. Other analysts seem less convinced. Anthony Boles, analyst at Titanium Capital, singles out Remgro and Reinet as companies with good quality assets, trading at meaningful discounts.
Graeme Korner, analyst at the Korner Perspective is watching Coronation (PE 10x, DY 11.0%) and Ninety-One (PE 11x, DY 7.0%), which could do well if the market does well. “The yields are good and, geared to the market plays (movements), may not be a bad space to be,” Korner says.
BOTTOM LINE: Last week we wrote: “2023 will be a year of, first pain, then gain.” A slowdown in global economic activity in 2023 seems almost inevitable. We will review these ten share picks in January 2024 to assess their performance, or lack of performance. We all read the same newspapers, we all have the same data, yet we interpret and process the information differently. It is one of the marvels of investing. These share picks should not be seen as investment advice. For investment advice you are welcome to contact one of our friendly and experienced consultants. They will take the sting out of investing. Source: Financial Mail, Investopedia.
The Bottom Line: Innovation and the Magic of Compounding
By Carel La Cock
The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.
Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.
After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.
Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.
As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.
Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.
Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.
Spend some time with our team to find out which one of our portfolios is best for you.