Is it time for offence or defence?

There is a growing belief that cyclical, “value” shares represent the latest opportunity in the market, but we advise caution as valuation is not always enough to unlock returns.

Feb 22, 2021

5 minutes

Duane Cable
There is a growing belief that cyclical, “value” shares represent the latest opportunity in the market, but we advise caution as valuation is not always enough to unlock returns.
The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.
–Warren Buffett

Despite the ongoing social and economic disruption of Covid-19, we start 2021 with quite a bit of positive news for investors. Fortunately, the US elections and Brexit are now behind us and the rollout of multiple COVID-19 vaccines around the globe has commenced. The current environment of record low interest rates and unprecedented stimulus is favourable for risk taking and the current consensus view is that the year ahead will be a good one for risk assets.

While the favourable conditions discussed above would usually be quite suitable for an offensive strategy, in our opinion certain areas of the market seem to be getting ahead of themselves. We believe many have ignored the potential tail risks we are likely to face over the next few months as we continue to recover from the devasting impacts of the pandemic. The era of free money has led to some elements of speculative behaviour. This is evidenced by increased retail interest, notably from Reddit members, and the popularity of app-based low-commission stockbrokers such as Robinhood. We have seen a growing disconnect between Wall Street and Main Street as markets continue to rally in the face of the significant economic damage caused by Covid-19. Despite increasing signs of slower-than-expected vaccine rollouts, different mutations of the virus potentially impacting on efficacy of vaccines, rising job losses and small businesses having to close their doors, the stock markets continue to march higher. The fear of missing out has caused some to abandon any defence in their portfolios and risk scoring a few own goals in the process.

We have been quite bearish on the outlook for local equities for some time.

While some investors might want to be more defensive given elevated risks, the income desert both locally and globally has meant that hiding in cash is no longer viable in the pursuit of inflation-beating returns. In our opinion, the current environment requires investors to have a balance between offence and defence when constructing portfolios.

The below chart highlights the expected annual returns for our current holdings over five years:

Figure 1: Range of expected returns for current holdings over five years

 Range of expected returns for current holdings over five years

Source: Ninety One. Index returns to 31 January 2021.These are based on Ninety One assumptions and are not guaranteed to occur.

Global equity

The most hotly debated view currently is that high-quality global equities are expensive. Some believe that we have seen the start of a multi-year rotation to more cyclical stocks, which supposedly are more attractively priced. We, in contrast, remain optimistic on the prospects for the concentrated selection of high-quality global stocks we own in the portfolios. We believe the market has consistently under-priced these quality companies and their ability to compound over time. In our view many of these cyclical shares are not as “cheap” as many believe and certainly carry a greater degree of forecast risk given the reliance of macroeconomic drivers. The rotation to more cyclical stocks over the last six months, which have largely been funded by selling the high-quality businesses we own, has also resulted in more attractive valuations in our quality universe. The range of expected returns around our forecasts is reasonably narrow for the businesses we own given their growth outlook is less dependent on macroeconomic cycles. We are however mindful of the risks to global markets and have catered for these risks through prudent asset allocation and position sizing of individual holdings.

SA nominal bonds

The best local opportunity remains government bonds which provide a real return in excess of 5%, which is attractive relative to historical real return expectation for bonds of 2-3%. Local bonds also provide a natural hedge against the volatility of the South African Rand and bring stability to the portfolio given our exposure to offshore equities.

SA inflation-linked bonds (ILBs)

We believe ILBs with short durations (less than 10 years) are particularly attractive given the muted inflation expectations priced into shorter dated maturities, relative to our base case inflation forecasts, and that these should form part of a diversified portfolio. The risk of short-term real yields rising is offset by the very low duration and, to a lesser extent, the coupon. For longer dated maturities (greater than 10 years), we prefer nominal bonds.

SA equity

We have been quite bearish on the outlook for local equities for some time. While valuations are more attractive, the prospects for many ‘SA Inc’ businesses are still dependent on an local economic recovery. Unfortunately, the timing of this recovery is incredibly difficult to forecast given the ongoing uncertainty around Eskom, continued job losses, regulatory uncertainty and low business and consumer confidence.

Current valuations of many of these businesses incorporate some level of recovery and if the expected recovery does not happen, we believe investors will once again be disappointed with returns. Based on our scenario analysis the range of future expectations is quite wide and thus we have lower conviction in the asset class given the elevated risk. It is therefore important to be selective and disciplined around security selection on local growth assets based on valuations. If our more optimistic scenario plays out, we will prove to have been too defensively positioned.

SA cash

Over the last 5 years investors could hide in the safety of cash and earn real returns in excess of 2%, which is high by historical standards. The prospects for cash have deteriorated significantly given the 300bps cut in interest rates during 2020. With cash rates at 3.5%, we do not believe that cash will deliver real returns for investors over the next five years, based on our inflation outlook of 4-5%.

SA property

The returns from the local property sector have been abysmal over the last few years as expensive valuations, excessive gearing and unsustainable dividends have finally made investors realize that property is not a one-way bet. We believe the prospects for local property are too binary given our bottom-up forecasts and do not believe they offer attractive risk adjusted returns.

Global bonds

We do not believe global bonds offer any value given record-low interest rates and unattractive global yields, which in our view do not offer downside protection in the event of interest rate normalization.


At R15/$ the rand is marginally weaker than current levels implied by Purchasing Power Parity (PPP) modelling. Our base case forecasts imply that the rand should depreciate between 1-2% p.a. over the next five years.

In terms of outlook for the year ahead, we continue to focus on the highest quality opportunities.


In terms of outlook for the year ahead, we continue to focus on the highest quality opportunities. In the context of South African assets, this means government bonds, which will generate income for the portfolio. We balance this with growth in the form of high-quality global equities with low leverage, low economic sensitivity and exposure to growth vectors unavailable to us in South Africa. As always, we remain unwavering in our commitment to growing your capital in a judicious and discriminate manner. We reiterate that “the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs” and believe that a balance between offense and defense is required to navigate through the expected volatility in the year ahead.

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Authored by

Duane Cable
Head of SA Quality 

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