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Buckle up for a tough situation worsening even further in 2017. The only hope is to go very defensive and wait for the bulls to return.
If you thought 2016 was a tough year, hang on to your hats because 2017 is going to show us that last year was just the warm up.
In the lead-up to the ANC elective conference in December we’re likely going to experience a deafening roar from the ruling party as members jockey for position. On the back of this (and in part because of the noise) growth will continue to limp along – hardly able to get above 1% and the rating agencies will be circling, eager to make us junk. Likely they will strike in June, downgrading us and worsening a tough situation.
Foreign investors who have been selling local equities and bonds will sell with increased speed, pushing our market lower and the rand weaker against major currencies and increasing our cost of government debt as buyers shy away from new bond offerings.
Commodity prices will most likely kick off the New Year by moving sharply lower as traders realise there is no improved demand and that oversupply remains the reality. The weaker commodity prices will see a rush out of mining stocks and even the weaker rand won’t be able to save the day as we see the local mining stocks collapsing after their amazing 2016 run.
A weaker rand also means inflation will rear its head and while the Reserve Bank is worried about growth, it might ultimately decide that rampant inflation is the bigger concern – in which case it will start to raise rates when the hope had been for rate cuts during 2017. This will lead to the consumer starting to crack on the back of higher inflation, interest rates and transport costs.
Banking sector
So, after a shocking 2016 for retail stocks, 2017 could get worse with sales going backwards, sending the shares to multiyear lows with no sign of recovery. Banking stocks could be hit especially hard as their non-performing loans (NPLs) skyrocket.
In this worst-case scenario, how does one build a portfolio and make money from your investments? We need to go very defensive with many rand hedges, clearing the decks of retail and banking stocks with the latter suffering from the double hit of the downgrade to junk and a worsening consumer situation.
The NEWUSD exchange-traded note (ETN) from Absa would be a firm favourite. As the rand weakens, this ETN will move higher in lockstep with the currency. But as it offers no operational leverage, we should also look to dual-listed stocks and those making significant profits in dollars and pounds.
Brexit
Brexit will continue to haunt the UK and beaten-down Brait* and Steinhoff* will both offer a hedge against the weaker rand. While their operating markets are under pressure, excellent management teams, and global expansion in the case of Steinhoff, will see improved profits coming through when these are converted to rand.
An easy win will be the US markets as they continue higher into new all-time highs. Coupled with a weak rand, the new CoreShares S&P 500 exchange-traded fund (ETF), CSP500* will soar from the double boost of higher US markets and weaker rand, both adding to its value.
Food sector
Food retailers will see some light at the end of the tunnel as the rains reduce the cost of production and hence take some pain out of food inflation, but with consumers under pressure this space will continue to be tough. Shoprite* is one food retailer that should be able to benefit as consumers shop down. Its rest of Africa operations should do well and see increased profits thanks in part to a weak rand.
Small-cap stocks
With the overall market weak and moving lower, small- and mid-cap stocks will be especially hard hit as liquidity dries up. Investors just stay away from the smaller stocks when trouble hits, so expect them to be especially vulnerable. The right strategy is to exit them sooner rather than later, especially in the case of those with mostly local exposure. Metrofile* may be an exception as it has a very defensive business in storing documents that are a legal requirement for companies and its strong cash generation will ensure an attractive dividend yield.
The most important point to remember is that bad times never last forever, so while it will be tough, we need to protect our portfolios to benefit when the bulls return.
*The writer owns shares in Metrofile, Shoprite, CSP500, Brait and Steinhoff.
This article originally appeared in the 29 December edition of finweek. Buy and download the magazine here.
