Weekly Market Report

16 May 2023

Global Report

Best performing country index, year-to-date.

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Local Report

Anglo American.

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Market Indicators

Global and Local Indicators.

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Global Report

By Nick Downing

Of all major equity indices, the Nasdaq has posted the best year-to-date return at 23.5% but the US country-wide benchmark, the S&P 500, has returned a lower 8.2%. It may surprise some, as Japan has been off most investors’ radars over the past two decades of deflation, that the Nikkei 225 has been the best performing developed market index YTD, with a 16% return. Japan’s economy is benefitting from a relatively recent Covid reopening and close trade ties with China, which is rebounding from last year’s steep decline. Japan’s economy has emerged from its decades-long deflationary spiral. Wages are seen as the key to lasting inflation and the spring wage negotiations concluded a 2.14% base pay increase, up from 0.62% last year. Two of the country’s industrial giants, Toyota and Honda, agreed to 5% wage increases.

Despite the economy escaping recession and inflation’s welcome return, the Bank of Japan is sticking to negative interest rates and an asset purchase programme to cap the 10-year government bond yield at 0.5%. The BOJ is alone in the world, in providing generous monetary policy accommodation, but economists are predicting a shift.

The BOJ’s new governor, Kazuo Ueda presided over his first policy meeting in April. He is the first academic at the post, chosen to normalise monetary policy following his predecessor, Haruhiko Kuroda’s massive 10-year stimulus. Under Kuroda, the BOJ expanded its balance sheet to 120% of GDP. Through its asset purchase programmes and defence of its bond yield cap, it now owns 54% of all outstanding government bonds and half of domestically listed exchange trades funds. As a result, the bond market is no longer functioning as it should. Liquidity has dried up and much needed bond collateral is scarce.

It is widely expected that under Ueda, the BOJ will aim to restore the bond market’s key functions by adjusting the bond yield cap and possibly removing it altogether. At the same time, the key interest rate is likely to rise from minus 0.1%. Consumer price inflation is expected to hit 4.5% by mid-year well above the BOJ’s 2% target. At his first policy meeting, Ueda said, “Compared to before, we’re now able to have some hope that the 2 per cent inflation target can be sustainably reached.” The accompany policy statement also dropped its long standing forward guidance that the BOJ “expects short- and long-term policy interest rates to remain at their present or lower levels.” Ueda is clearly laying the groundwork for a monetary policy pivot.

There will be financial market ramifications. Asset prices will need to adjust to higher bond yields, bank balance sheets may unravel in response to falling bond prices much as they did during the US mini banking crisis in March. Homeowners will need to adjust to rising mortgage interest rates. However, Japan’s banks are in good shape, far better than most and Japan’s household debt is low. The country has not had a property boom or credit boom since the early 1990s. The global impact of Japan’s monetary policy normalisation is likely to be greater than the local impact. Rising short- and long-term Japanese interest rates will choke off the lucrative “yen carry trade”, whereby debt is raised in yen at low interest rates and invested at higher rates in other countries. Global yen denominated debt may no longer be a key source of global liquidity. At the same time, Japanese institutions will increasingly repatriate their offshore funds. The result is that the yen will strengthen.

An end to the BOJ’s so-called “Yield Curve Control” (YCC) has been cited by some investment strategists as a key risk to global financial markets. Yet, global markets are likely to suffer more than Japan’s. The yen’s ensuing appreciation will help amplify Japanese investment returns. Warren Buffett, a recent advocate of Japanese investing remains undeterred. Having had little interest in Japanese investment for most of his illustrious career, Buffett has invested significant amounts since 2020, steadily accumulating strategic stakes in Japan’s five biggest trading houses. He has amassed a 7.4% stake in each of Mitsui, Mitsubishi, Sumitomo, Marubeni and Itochu. He funded his purchases through yen debt and is reportedly planning another debt issue, raising speculation that an additional Japanese acquisition is in his sights.

Buffett is known for his “value” investing style. Besides Japan’s success in defeating deflation, he must be drawn to the extremely cheap valuations on offer. The five trading houses trade at sub 10x price earnings multiples and close to 5% dividend yields, but the whole market is ridiculously cheap. The Nikkei trades at an estimated forward PE ratio of 12.8x compared with a long-term average of 24x and a price-to-book of 1.28x compared with a long-term average of 1.34x. The dividend yield is 2.53% compared with a long-term average of 1.34%. Valuations are compellingly cheaper versus global averages and their cheapest versus the US markets in 50 years.

Overberg Asset Management has substantial exposure to Japanese assets in its global private share portfolios, drawn by the country’s steadily improving corporate governance and greater board emphasis on shareholder returns. As the country wakes up from its long deflation induced hibernation, economic activity and corporate earnings are likely to expand at well above the long-term average pace, delivering improving returns for investors. The end of YCC and its implications for yen appreciation could add to Japan’s expected equity market outperformance.

Local Report

By Gielie Fourie

INTRODUCTION: Anglo American (Anglos) was founded in 1917 and has since grown to become one of the world’s largest diversified mining companies. Anglos has had its share of challenges over the years. It operates in various parts of the world, and like many other companies in the industry, it has faced a range of challenges over time. One major challenge that Anglos has faced is the cyclical nature of commodity prices. Commodity prices are cyclical because they are subject to fluctuations based on global demand and supply factors, which can impact the profitability of mining operations. Anglos has had to adapt to these fluctuations and adjust its operations accordingly. Stuart Chambers, Anglos’ chairman, commented: “Anglo American is a major producer of many energy-transition metals and minerals needed for a cleaner, greener world. As a recognised industry leader in sustainability innovation, we also continue to focus on the implementation of new technologies that are hastening the pace of decarbonisation.”

Despite these challenges, Anglos remains a significant player in the mining industry. Anglos is listed on several stock exchanges worldwide, including the London Stock Exchange, the Johannesburg Stock Exchange, and the Australian Securities Exchange. Between May 2008 and September 2021, Anglos’ stock price experienced a lot of volatility. There were periods of growth, followed by periods of decline. Its price dropped from around R500.00 in 2008, to R52.69 on 20 January 2016. There were fears that Anglos could be a takeover target. Overall, however, the trend was upwards. It is currently trading at R565.00, a tenfold increase over seven years.

FINANCIALS: Anglos has a strong balance sheet with net assets worth $34 billion (R646 billion). It is a big company with a market capitalisation of $40 billion (R756 billion). Net debt of $6.9 billion is manageable and adequately covered by assets. Earnings per share is $4.97, dividend per share is $1.98. (Figures for the financial year ending 31 December 2022). 2022 was not a good year for the mining industry. Anglos’ current share price is R565.00, down 13% Year-on-Year. The current Price Earnings ratio is 6.98x, and the dividend yield is 6.1% per share.

DIVERSIFICATION: Anglos is well diversified. Not only with the basket of commodities that it mines, but also geographically. Its basket of commodities includes diamonds (through De Beers), copper, nickel, platinum group metals (platinum, palladium, and rhodium), iron ore, steelmaking coal, manganese, and crop nutrients. It has demerged its South African thermal coal mines. It operates in several regions around the world, including Africa, the Americas, Asia, Australia, and Europe. Materials used in battery production are graphite, silicon, titanium, cobalt, lithium, copper, manganese, and nickel.

LESS COAL AND MORE COPPER: In 2018, 34% of Anglos’ revenues and profits were generated by coal. At the time it was its main source of income. Anglos wanted to change that and move over to cleaner energy. The Chief Executive Officer (CEO) at the time, Mark Cutifani, said: “Anglo American will remove SA thermal coal from its portfolio within three years.” Thermal coal is the “bad, dirty and toxic” coal used for electricity generation. Anglos kept the cleaner metallurgical coal, the “good, clean and green” coal used for steelmaking. Early in 2022 Anglos achieved this goal by selling its “bad” coal to Thungela.

Anglos then focussed on the production of copper in South America, especially the Quellaveco copper mine in the south of Peru, jointly owned by Anglos and Mitsubishi Corporation, with Anglos holding a 60% stake and Mitsubishi holding a 40% stake. The Quellaveco mine is estimated to have approximately 1.1 billion tonnes of mineral reserves, with an average copper grade of around 0.55%. This makes it one of the largest undeveloped copper deposits in the world. Once fully operational, the Quellaveco mine is expected to produce around 300,000 metric tons of copper per year for at least the first ten years. Quellaveco is also expected to produce significant quantities of molybdenum, a valuable by-product. The mine is anticipated to have a lifespan of over 30 years. Production is scheduled to commence in 2023. CEO Duncan Wanblad is quoted as saying: “The world requires 60 new Quellaveco projects to supply the copper that would contain global warming to 1.5oC by 2050, as set down by the Paris agreement. This is equal to $330 billion in new investment in just one single commodity. But when all the metals needed for electric vehicle batteries are considered, the investment is far higher.”

BOTTOM LINE: Anglos is mining several of the so-called green metals, especially copper. Metal prices have dropped substantially during the last year. Share prices of mining companies dropped in tandem. There is now more upside than downside potential for mining companies mining the appropriate green metals. Investors should not invest without a plan. Please use this information as a reference only, rather than as a basis for making investment decisions. If you are interested in taking advantage of the current opportunities available in mining, you are welcome to contact one of our friendly consultants as soon as possible.

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Reference: Capital Economics – Historical bond and equity return data.

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.

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