Market Report

19 March 2024

Global Report

Global Market Prospects.

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Local Report

Local Market Prospects.

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Market Indicators

Global and Local Indicators.

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Global Report: Global Market Prospects

By Nick Downing

Japan’s first new high since 1989

Japan’s Nikkei 225 index has struggled over the past 34 years to reach its previous market peak set in December 1989. In the 1980s, cheap credit and excessive speculation led to a frenzied bubble, catapulting Japan to 37.5% of the world’s equity market capitalisation. Today, Japan accounts for less than 7%. Back then 15 of the world’s 20 biggest companies by market capitalisation, were Japanese and 6 of the world’s 10 richest people were Japanese. Now only 3 are ranked among the world’s top 100 billionaires. Recently, equity market performance has been picking up. The Nikkei gained 28% in 2023 and is already up by 16% since the start of 2024. Foreign investors are taking notice, sentiment towards Japanese equities is extremely strong. Those not invested could be forgiven for suffering the early onset of FOMO. Why is the market surging and is it sustainable?

Japan has traditionally been a very cyclical market, rising and declining with the ebb and flow of the global trade cycle. Early signals such as export figures from Korea and Taiwan and economic activity in Singapore together indicate improving global trade, which is beneficial for Japanese earnings. There are also structural longer-lasting reasons for the re-rating in Japanese equities. It appears that the country is finally waking up from its decades long struggle with deflation, which has been crippling for credit growth, investment outlays and consumer spending.

Consumer price inflation (CPI) has remained above the Bank of Japan’s (BOJ) 2% inflation target for over 2 years, and rising wage growth suggests positive inflation will be sustainable. Although much depends on the outcome of the annual Shunto wage negotiations between companies and unions, BOJ policy member Junko Nakagawa recently stated that “There is a clear change in stance in companies’ wage-setting.” The BOJ is increasingly confident that deflation has been beaten and is expected to finally make a start with exiting negative interest rates at its upcoming policy meeting on 19th March.

Perhaps more significantly, the shift in structural reforms, corporate restructuring and improved corporate governance is gaining momentum, to the benefit of profit margins and shareholder returns. The Japanese corporate landscape used to be dominated by the “keiretsu” system with intricate cross-shareholdings among companies making it difficult for shareholders to exert influence or challenge management decisions. The system created stability but hindered corporate governance practices and the efficient allocation of capital. Weak profit growth and bloated balance sheets which often ensued caused many Japanese companies to trade at price-to-book ratios of below 1. In other words, they would be worth more if they were broken up and sold. The shift towards unlocking these discounts may be hitting a tipping point as companies are Japanese companies are increasingly prioritising shareholders over other traditional stakeholders. 

Japanese companies are increasingly recognising the opportunities for value creation through higher dividend payouts, share buybacks, more efficient allocation of capital, the sale of non-core assets and the sale of crossholdings. JPX, the group controlling the Tokyo Stock Exchange announced in December new rules which oblige companies persistently trading below book value to disclose plans to remedy that situation. Seth Fischer, chief investment officer at activist fund manager Oasis said “The value trap that is Japan is no longer… What was a market full of companies continuing to hoard capital and happy with their market share has become one where management, for a whole host of reasons, is now focused on increasing profitability and shareholder return.”

The sharp rise in Japanese equities over the past 12 months has been equally spread across market sectors. Broad based participation in the bull market is illustrated by similar performance in both the equal weighted index and the overall aggregate, suggesting the rally is on a sound footing. Independent research firm MRB Partners reports that industrials, consumer discretionary, technology and financials, the four largest sectors of the market which together make up a combined 70% of total market capitalisation, are all in solid uptrends. Valuations are cheap despite the recent advance. Despite rising profit margins and returns on equity, the industrial sector is trading at a 12- month estimated forward price-earnings multiple of 15x, in line with the median of the past two decades, the consumer discretionary sector is trading on a 12x PE below its two-decade median, while technology is on a 23x PE which is higher than the median but cheap compared to the world’s other technology markets. Financials trade on a 10x PE and a 20% discount to book value, cheap due to the chronic low interest rate environment but net interest margins should benefit as the BOJ starts to normalise interest rates. Overall, Japanese equities trade at a moderate discount to the global benchmark on a forward PE basis, and even more strikingly undervalued on a price-book basis, at a 50% discount.

Currently, foreign investors favour Japanese equity markets above all others from a purely sentiment perspective. Japanese investors are not yet persuaded despite the government’s incentives. For most households, the memory of the steep post 1989 decline and the lost decades of deflationary performance remain too raw. Some analysts including Bruce Kirk, chief Japan equity strategist at Goldman Sachs believe the market’s recent breakout above the 1989 peak achieved on 22nd February will provide a strong psychological boost for domestic investors. “It’s an incredibly important barrier for Japan to have finally broken through.”

Japanese households are sitting on a massive savings stockpile of $7.7 trillion, which if partly shifted to equity markets could provide a significant lift to performance. In January this year, the government raised the limit on tax free contributions to the Nippon Individual Savings Account scheme, from ¥1.2 million to ¥3.6 million for annual contributions while the cumulative limit was raised from ¥6 million to ¥18 million. Only 13% of Japan’s liquid household assets are invested in equities compared with 40% in the US and 21% in Europe. In the words of MRB, the BOJ’s expected exit from negative interest rates “should reinforce in investor eyes that the deflation era has passed, and more “normal” economic conditions are developing”, paving the way for further market gains.

Local Report: Local Market Prospects

By Gielie Fourie

Profits on Gold and Foreign Exchange Contingency Reserve Account (GFRECA)

INTRODUCTION – WHAT IS GFRECA? The foreign exchange reserves of any country are represented by the gold and foreign currencies like dollars, euros, and pounds held by the central bank. The official name of the account is the “Gold and Foreign Exchange Contingency Reserve Account” (GFECRA), pronounced G-FECRA. South Africa’s reserves are at an all-time high of just over $60 billion (about R1 150 billion) – see graph at the bottom. This amount includes paper (unrealised) profits and losses created by the substantial rise in the price of gold and the revaluation of the ZAR relative to strong global currencies. The current value of the paper profits amounts to around R500 billion. This money belongs to the state and can be transferred to Treasury.

THE R500 BILLION QUESTION: Should we tap into GFECRA? In his 2024 budget speech, Finance Minister Enoch Godongwana announced that the country would tap into R150 billion worth of paper profits of the country’s gold and forex reserves. In September 2023, the Institute for Economic Justice (IEJ), a group of South African academics, and activists, suggested that government tap into the majority of the R500 billion reserves. This suggestion aligns more with a moral than an economic perspective. Initially the suggestion was met with sharp criticism from both SARB president Lesetja Kganyago and Finance Minister Enoch Godongwana. However, with GFECRA they later capitulated.

In 2017 the two gentlemen also worked together and successfully defended the SARB against nationalisation when the Zuma presidency wanted to get control of the SARB. Treasury will use R100 billion in the coming year to pay down debt and then R25 billion respectively in 2025 and 2026. Duncan Pieterse, Director-General of the National Treasury, said in an interview the transaction will be very costly. The gross amount that will be withdrawn from the GFECRA will be R250.00 billion – roughly halving the paper profits in one fell swoop. Below is a summary of the current reserves.

WHY DO WE NEED STRONG RESERVES? We need strong reserves to protect us from unforeseen disasters – Covid-19 is a good example. Heightened geopolitical tensions could easily set off panic in the financial markets, with investors heading away from risky countries such as South Africa to safe havens such as the US. Were that to happen when South Africa had reduced its “insurance” cover, which would be a sure way of sending our country into the clutches of an IMF structural adjustment programme. The decision to use a portion of the GFECRA to finance government projects is attractive but absurd. Now is not the time for the kind of fallacies and follies the Treasury is pursuing. The president of the SARB, Lesetja Kganyago, told reporters in November 2023 that diminishing our reserves could have the potential of leaving us open to vulnerable future shocks. A full withdrawal could jeopardise the independence of both the SARB and the Treasury. At worst, it is reckless. It will be a once off temporary solution. The previous time this was done was in 2003.

CRITICS OF SELLING OUR RESERVES: The deputy governor of the SARB, Rashad Cassim, has warned, that tapping into the reserves will have serious cost implications for the economy, the SARB, and the country. Peter Attard Montalto, MD of research and consulting firm Krutham, is sceptical the Treasury is tapping into the account. He said the SARB would end up having to print money. Peter Bruce wrote in Business Day – “Raking in money from the great GFRECA pot is like printing money.”

Using this vehicle (GFRECA) in an election year is “delightfully serendipitous,” according to Professor Andre Roux, an economist at Stellenbosch Business School. Dion George, Democratic Alliance (DA) Member of Parliament, expressed dissatisfaction with the move: “We do not support what is, in effect, a bailout from the SARB’s reserves.

PROPONENTS OF SELLING RESERVES: The ANC defended the use of the reserves, emphasising the need to address pressing economic challenges, even if it means tapping into the reserves. Economist Duma Gqubule, of the Centre for Economic Development and Transformation, said South Africa was free to use the reserves to raise money without getting into debt. “There are many options that we could use to kick-start the economy. Our foreign exchange reserves are high by international standards.” Redge Nkosi, of advisory firm Firstsource Money, said “We can tap into it. Shifting money to the government for spending on infrastructure, public services and catalytic projects was a promising investment and critics were using “misguided scarecrow tactics.”

NEW AGREEMENT: Min Godongwana and SARB president Lesetja Kganyago believe they have reached an agreement that will provide a lasting framework to guide their staff, even after they personally no longer head up the two institutions. To mitigate risks National Treasury said the new framework of GFECRA will be split into three buckets. The first bucket will hang on to sufficient funds to absorb exchange rate swings. Once that is done, funds will flow in a waterfall to the second bucket, a Reserve Bank contingency reserve to ensure the central bank’s solvency. Once the first two obligations have been settled, funds will flow into the third bucket that will be distributed to National Treasury. GFECRA funds will be ringfenced to pay down debt. A fiasco similar to the Oilgate disaster of 2015 when a minister sold off South Africa’s entire strategic oil reserve must be avoided at all costs.

The graph below indicates the rapid growth of our forex reserves since 2003. By comparative international standards, our reserves are high.

South Africa Foreign Exchange Reserves 1998 – 2023



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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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