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A cautiously optimistic look

Investor pessimism arguably peaked during the ‘Nenegate’ crisis late last year but for all intents and purposes the political, economic and market trajectories are now looking considerably better. 

This view was expressed in a meeting we had in Cape Town with Arthur Karas, portfolio manager at Old Mutual Investment Group, talking about the R4.7bn Old Mutual Flexible Fund. His fund returned an annualised 6.2% in real terms during the past decade and 8% over five years, particularly impressive given the South African economy’s most prolonged phase of weak growth since 1994. At stages the economy teetered on recession. 

The economy’s thumbs down, of course, had been accentuated by negatives faced by most other emerging markets, severe drought locally, political discontent, deteriorated business confidence, the consumer on the ropes, and fiscal policy hindering rather than helping growth over the medium term.  

On the positive side, however, Karas points to concerted efforts being made currently by central banks to ensure that the global economy doesn’t worsen, which would suggest that interest rates will not be increased meaningfully for the next three to five years. 

One consequence will be the continued search for yield across the globe, encouraging institutional investors such as pension funds to enter more risky terrain.  

“Even a company such as Naspers* has become significantly more valuable than it would have been under benign circumstances,” he says. “It’s a rapidly growing company that has no correlation with the macro economy struggling to offer anything illustrious.” 

Economic growth however is unlikely to come in rapid surges, Karas warns. “We seem headed from bad to less bad, but relatively speaking emerging markets should become more attractive. The US dollar, for instance, is likely to get technically weaker, which will mean stronger commodity prices. 

“Moreover, we think that metal prices have probably bottomed out, underpinned by mining companies extracting capital rather than investing in new capacity. They’ve invested massive amounts of capex for years, returns were poor, and now they’re selling assets and shutting down mines.” 

This was particularly evident in the case of Anglo American and Glencore, Karas points out. “Both performed very badly in recent years, they’re now fixing up their balance sheets, so the drive for better returns will not necessarily emanate from higher profits, but the utilisation of less capital to achieve those same profits.” 

Karas discounts a big boom in commodity prices, however. 

“There are people buying gold because they believe that it will be a hedge against significant money-printing by the banks, but we are seeing no signs of inflation.”  

On immediate local economic performance, he suggests that the effects of the drought are likely to ease significantly, leaving room for inflation to come off considerably more rapidly than generally believed. “We are probably at the peak of our interest rate cycle.” 

What we do know from past experience, he adds, is that if you think that interest rates are about to start falling, you need to reposition your portfolio before that happens. Past patterns have shown that lower interest rates immediately benefit the consumer economy, consumer stocks, and companies that sell products on credit. 

This has already been reflected in the relatively sharp rises in share prices such as Shoprite and Imperial.  

“So we have started tilting our portfolio in that direction,” he points out. 

Karas also likes local banks, but is less confident about certain listed property stocks in view of emergent oversupply of offices and retail space, especially in Sandton. “You have a number of very large developments happening, and this could create some speed bumps. Large corporates moving into new head offices are going to leave whole buildings behind.” 

Albeit that rand-hedge defensives such as British American Tobacco have a place in any good portfolio, Karas doesn’t expect any fireworks from them. “Major upwards earnings surprises are unlikely.” 

Two prominent companies that he is temporarily wary of at present, are Richemont and Sasol. Richemont because of reduced luxury spending in the likes of Hong Kong and Paris, coupled with oversupply at the super-end of the watch market. “There is just too much stock out there and too many stores in Hong Kong specifically. This won’t be permanent, but Richemont needs to digest that.” 

Sasol, Karas says, is attractive to hold if you’re negative on the rand. More disconcerting is Sasol’s mega chemical project in the US – it’s spending more than was intended and has potential to destroy shareholder value. 

“Mega projects of this nature aren’t generally great,” he argues.

*finweek is a publication of Media24, a subsidiary of Naspers.

This article originally appeared in the 15 September edition of finweek. Buy and download the magazine here.

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