Every day I wake up to another article in the media imploring investors to take their money out of South Africa. Unfortunately, making money in the equity market is not as easy as reading the newspaper and looking at what is going on around you. If it were, there would be a lot more rich people out there.
The key to investing is to try and work out how much of what is in the newspapers and what is happening in the streets is in the price. Making money out of investing on information that is fully known by the market is not possible – that is why insider trading is so lucrative (and illegal).
On this basis, an investment in South African equities should at least be considered. Is there anyone on this planet who doesn’t know the litany of woes that is South Africa? Five years ago, at the height of the “Ramaphoria’ equity surge in South Africa, I argued the other way. As a result, I positioned the portfolios I manage (which include the Ninety One Value Fund) accordingly, holding almost no ‘SA Incorporated’ stocks, as the market discounted a market-friendly new regime with no President Zuma at the helm. That didn’t work out so well given the relatively high valuations paid for SA stocks, together with the subsequent disappointments SA delivered. Five years later one thing has changed: the price of SA equities. And when the price changes, I change my mind.
South African equity valuations now fully discount the current reality and appear to me to be discounting loadshedding in perpetuity. The JSE All Share Index’s price to earnings ratio of 11 is near the bottom of its long-term trading range but is an aggregated valuation measure which is distorted upwards by the high valuations of the large-cap dual-listed stocks such as Naspers and Richemont and distorted downwards by the low historic valuations of the resource stocks trading on the JSE.
In order to get a fairer reflection of the valuation being applied to ‘SA Incorporated’, we would use Nedbank Group as proxy – a liquid name which is 90% exposed to the SA economy. Five years ago, as investors drank the Ramaphoria Kool-Aid, the shares traded at R300 on an exchange rate of 12 rand to the US dollar – the valuation was a 12,5 PE/4% dividend yield and 1,8 times book value.
Fast forward five (disappointing) years and today the shares are trading at R200, the rand is at 18 to the US dollar and investors who liked the SA of five years ago are down 56% in US dollars on their Nedbank investment. And the valuation? Now a much more interesting 7 PE/8% dividend yield and just 0,9 times book value. Furthermore, Nedbank is better capitalised than five years ago.
A starting yield of 8% can cover a lot of bad outcomes and we would argue that while this valuation doesn’t discount the case that SA becomes Zimbabwe or Sudan, it certainly discounts no improvement ever in SA’s long list of problems.
What about positioning in SA equities? An attractive valuation is one thing but if there remains a long list of sellers the shares may well fall for a longer time than one can stomach. Fifteen years ago, SA balanced funds held 63% of their assets in SA equities – today it is 40%. The SA unit trust domestic equity category now has close to 35% offshore (from 20% five years ago) and is probably on its way to the maximum allowed 45% level.
Foreign investors are a more important gauge as they represent the marginal buyer/seller, i.e., they are effectively outside the system and their buying and selling will determine the price to an even greater extent. Here the positioning is even more negative, with foreign emerging market (EM ) investors now holding a one third under-weight position against their respective GEM (Global Emerging Market) benchmarks– a position that has led to R600 billion of foreign sales of JSE equities over the last five years. Our conclusion here is that foreign selling is exhausted and local selling is 80% done – it is extremely unlikely ever to time the bottom of a market, but these statistics show how well advanced the ‘short’ SA trade is. A concrete sign of foreign investors’ distaste for SA was seen in the March Sun City SA conference run by a large international investment bank – it attracted only 14 foreign institutions versus 33 before COVID!
There is an old adage in the market: “Buy on the sound of cannons, sell on the sound of trumpets.” Perhaps in SA’s case this should be changed to: “Buy when the lights are off, sell when they come back on”. Returns from this point look asymmetrical to us – an 8% starting yield on many domestic stocks to us suggests reasonable returns even on the ‘muddle through’ base-case scenario in which GDP remains stagnant.
Investors exiting SA equities to take their money to offshore equities should bear in mind that they are effectively selling Nedbank to buy Microsoft – this after Microsoft has outperformed Nedbank by 700% in US dollars over the last five years.
If you missed John’s recent quarterly Value Fund update, you can view it below.