Weekly Market Report

27 June 2023

Global Report

Is it too late to invest in Artificial Intelligence?

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Local Report

MTN and Vodacom.

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Market Indicators

Global and Local Indicators.

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Global Report: Is it too late to invest in Artificial Intelligence?

By Nick Downing

The US equity benchmark, the S&P 500 index is up by 13% year-to-date and up over 20% since its low point in October last year. A 20% move qualifies as a “bull” market confounding the sceptics at the start of the year with their prophecies of recession and doom. However, the upward move has been driven by a remarkably limited number of shares. According to US investment bank Goldman Sachs, the current stock market rally has been the narrowest since the dot.com bubble of 2000.

The S&P 500 index is a capitalisation or value-weighted index, which means each company’s weight in the index is proportional to the market value of its shares. The index comprises 500 companies. The companies with the largest market capitalisations, or the greatest values, will have the highest weights in the index. The rally in the S&P 500 index has been driven by the seven largest shares in the index, which combined make up an outsized 28% of its value. They are all technology driven shares, including Apple, Microsoft, Amazon, Alphabet, Tesla, Meta Platforms, and Nvidia, the latest technology company to break the $1 trillion market capitalisation barrier.

In 2003, the S&P 500 Equal Weighted Index (EWI) was created, an equal weighted version of the index. Although both indices comprise the same 500 shares, they have different weighting schemes. In the EWI, every share in the index has the same weight regardless of how large or how small the company. Therefore, Apple the largest constituent of the S&P 500, comprising 7.56% of the index would have the same weight as the smallest company. While the S&P 500 index is up 13% year-to-date, the equal weight index has barely budged. The S&P 500 index would be down if one excluded the seven technology giants. Globally, over half the constituents of the MSCI World Index are down YTD. Technology is leading the way, buoyed by surging interest in artificial intelligence (AI).

Is it too late to jump on the artificial intelligence bandwagon? Many analysts caution that valuations have run ahead of themselves, citing the dangers of previous equity market bubbles. Bubbles inevitably end badly, but they can persist for long periods, especially in a field as transformational as generative AI. This bubble could still be in its infancy, considering that media hype around generative AI only began in January when Microsoft announced its investment in ChatGPT. Goldman Sachs research concludes that AI could lead to a labour productivity boom similar to previous transformative technologies like the electric motor and personal computer. Productivity growth in the G7 economies has slowed since the turn of the century to an average annual rate of 0.8% compared with 1.8% in the 1980-2000 period. Goldman Sachs believes that generative AI could raise US productivity by a substantial 1.5% per annum.

Jen-Hsun Huang, the founder of Nvidia, which designs the advanced Graphics Processing Unit (GPU) chips that power artificial intelligence applications, said “we have reached the tipping point of a new computing era”, in which “everyone is a programmer.” Scottish Mortgage Investment Trust, a key holding in Overberg Asset Management’s global private client portfolios, added Nvidia to its portfolio in July 2016, when the share traded below $10.00. It has since risen above $400 per share, up an astonishing 180% YTD and trading at an eye-popping price-earnings multiple of 123x. Yet Scottish Mortgage are holding on to the share, as it believes “Nvidia’s opportunity in AI is still just beginning. Its capabilities underpin computational drug design, climate change simulation, speech recognition, automotive control systems, industrial automation, computer vision and much more… The markets it addresses are inestimably large, and Nvidia is developing a systemically crucial role.”

It is not too late to add portfolio exposure to AI. Some of the doyens of the investment industry share this view. Pershing Square Holdings, the £5 billion investment company, only recently added its sizeable stake in Alphabet at a 9% portfolio weighting. Overberg Asset Management’s global private client portfolios have exposure to AI via various holdings, most notably through Pershing Square Holdings Ltd, Scottish Mortgage Investment Trust plc, Rothschild Capital Partners plc and JPMorgan American Investment Trust plc. However, we believe that additional exposure is merited, via Allianz Technology Trust plc.

Allianz Technology Trust PLC (ATT) has a long and successful track record of investing in quoted technology companies on a worldwide basis. ATT has the competencies to sift through the winners and losers of the AI transformation. It has won several awards, including winner of the Association of Investment Companies (AIC) specialist category in 2021, and winner of the AIC shareholder communication award in 2022. It also has a 5-star Morningstar rating, the highest rating available. ATT is managed by Voya Investment Management, which is based in Silicon Valley where many of the world’s key technology companies are headquartered. The share price fell sharply in 2022 by 40.4% as technology companies, which tend to be valued by discounting earnings many years into the future, were especially susceptible to rapidly rising interest rates but the peak in central bank interest rate hikes is now in sight. While the share price has already gained by 23.4% since the start of the year, it is still a long way from recouping last year’s losses and still trades at a compelling 12% discount to net asset value.

AI is likely to be a transformative technology and likely to continue generating investor interest for a considerable period, certainly longer than it has done so far. Independent research company Capital Economics wrote on 16th June 2023, that “it will help to propel the stock market to a much higher level in 2024, aided by economic recovery and looser monetary policy… We wouldn’t rule out a bubble surrounding AI to inflate well beyond the end of next year.” While there are concerns over market valuations generally and the potential for a recession related global equity market sell-off, history shows that mega-cap outperformance, such as we have been experiencing, tends to continue even during an equity market sell-off. In addition, therefore, ATT should also bolster the defensiveness of client portfolios during these relatively uncertain times.

Local Report: MTN and Vodacom

By Gielie Fourie

INTRODUCTION: MTN and Vodacom are the two biggest mobile phone companies in South Africa. MTN was established in 1994 and was one of the first cellular network operators in South Africa. The company initially launched its services after the deregulation of the South African telecommunications sector. In its early years, MTN faced various challenges, including limited coverage and competition from other network operators. Over the years, MTN continued to grow, both organically and through acquisitions. It expanded its presence to several countries outside Africa, including the Middle East and Southeast Asia. MTN offers a wide range of services, including mobile voice, data, and digital services.

Vodacom was established as a joint venture between Telkom and the British multinational Vodafone Group. Vodacom launched its services in 1994 and quickly gained a significant market share. It introduced various innovative services and products, such as the first prepaid mobile service in South Africa. When Vodafone became the majority shareholder in 2009, Vodacom expanded beyond South Africa and established operations in other African countries. Both MTN and Vodacom have played significant roles in transforming the telecommunications landscape in South Africa. They have been instrumental in connecting people, driving digital inclusion, and enabling various technological advancements in the country. Today Vodacom is the biggest mobile phone company in South Africa, while MTN is the biggest mobile phone company in Africa. Both companies are considered core portfolio holdings.

Vodacom is trading at R116.00. It has a market capitalisation of R240 billion, a price earnings (PE) ratio of 12.26x, a dividend yield of 5.77%, a return on equity (ROE) of 18.59%, a return on assets (ROA) of 12.23%, and a price to book (P:B) ratio of 2.48x. Over the last three years the share price has dropped by 4.30%. It is interesting that since 2015 not a single director has bought any shares in Vodacom. Trading in shares by directors draws attention because it can give a glimpse of their view on the company’s prospects. When directors buy shares in their company, it is a vote of confidence. Directors, and directors of Vodacom’s subsidiary companies, are regular sellers of Vodacom shares. It raises the question why ordinary investors should buy Vodacom shares if the company’s directors are regular sellers. There may be very valid reasons for this. They may already have a big concentration of their wealth in Vodacom and prefer to diversify their wealth. Analysts’ consensus is that Vodacom is a Hold.

MTN is trading at R136.00. It has a market capitalisation of R256 billion, a price earnings (PE) ratio of 11.78x, a dividend yield of 2.43%, a ROE of 19.83%, a ROA of 13.90%, and a P:B ratio of 2.11x. Over the last three years the price is up by 144.48%. MTN has only slightly better financial ratios than Vodacom, but its share price growth over the past three has far outperformed that of its peer. In contrast to Vodacom, MTN’s directors were regular buyers as well as sellers of MTN shares over the last eight years. There was an equal split between buying and selling MTN shares.

MTN recently released its first quarter 2023 results. The balance sheet remains robust. In its outlook it said uncertainty remains as inflation is rampant across Africa. It downgraded its margins to factor in higher inflation and the outlook for loadshedding. MTN offers higher organic growth potential than Vodacom. Data and Fintech developments have been the main drivers. MTN’s asset realisation (sale of noncore assets) programme has allowed it to deleverage and strengthen the balance sheet. A significant risk is MTN’s material exposure to forex. Calculations show that 17% of the exposure comes from South Africa, and the rest comprises volatile currencies and inflation exposure in the rest of Africa. MTN Nigeria continues to be the key driver of revenue across voice, data, fintech (Momo) and digital services. Data continues to be a key growth driver for the business. Network availability in SA remains under pressure due to ongoing power outages across the country. There were approximately 90 days of load shedding in Q1 2023 compared to 14 days in Q1 2022. MTNs subscriber base is more skewed towards pre-paid than Vodacom. Prepaid subscribers are under pressure due to load shedding intensity and economic weakness. MTN has been looking at Telkom for many years for a possible merger or buyout. Last year MTN walked away from talks to buy Telkom – a deal that would have created South Africa’s largest mobile phone operator. Telkom shares dropped 25% as a result. MTN could look at Telkom again.

BOTTOM LINE: MTN and Vodacom have a duopoly in the South African mobile-phone market. Any competitor attempting to enter the market will have to fight, not one, but two giants. There are regularly bits of news regarding smaller companies, like Telkom – a former state monopoly, Cell C, and Rain Holdings, trying to compete in the market. The Public Investment Corporation, (PIC) which manages more than R2.5 trillion in assets, is in talks to team up with investors for a potential offer for a stake in Telkom. Even with this kind of backing, success cannot be guaranteed. The barrier to entry is high – this business is highly capital intensive.

Please use this information as a reference, rather than as a basis for making investment decisions. To take the emotion out of equity analysis, you are welcome to contact one of our friendly consultants for a free consultation.

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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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