James Downie of MitonOptimal South AfricaQuarter 2 2020 review

Several august journals, including the New York Times and Psychology Today, have described the feelings we have all experienced this year as akin to grief. Anxiety about the pandemic – certainly, depression about lost opportunities and cancelled plans – sure, but the diagnosis is that we have grieved this year. We’ve grieved the loss, tragically, of friends or loved ones from COVID-19 and we have endured minor grief, too. We’ve lost the freedom to roam outside without a mask, missed the Super Rugby and the Tokyo Olympics, endured a crowdless and abbreviated soccer season, not to mention a curtailed and hurried F1 season.  Inability to visit and comfort vulnerable family, cancelled weddings and milestone parties, missed holidays, even closed restaurants and hair salons have all contributed to grief in larger or smaller degree.

So, if it’s grief, where are we on the Kübler-Ross spectrum of Denial, Anger, Bargaining, Depression and Acceptance? Some have taken the range further to add Disbelief and Shock as #1 and inserting Guilt & Pain between Denial and Anger. The alleged leader of the free world spouts Denial from the White House so no guessing where he is on the scale along with the anti-maskers and it becomes an interesting debate where different cohorts of people lie on the scale. Restaurateurs are probably still in Anger, those who are ill or recovered somewhere between Bargaining and Depression.

However, the world’s share markets seem to have moved swiftly through the whole range to Tally-Ho and Off to the Races, my newly invented final stage on the spectrum. It seems as though the first quarter of 2020 ended at the end of Depression (coincidentally, many were forecasting just such an economic phenomenon) with markets down 30% to 40%. However, markets are meant to look through immediate troubles and price on the future and by the end of June, the NASDAQ was all but back to its 2020 high with other markets in hot pursuit.

But does that make sense and will it last?

The charts below show that the so-called V-shaped recovery has happened firmly denying and ignoring the fact that earnings for the vast majority of companies will be severely depressed at least until 2021 and, for many, will never recover.

MSCI ACWI – USD

Source: iGraph

The chart above is the All Countries World Index or ACWI which is a scorecard of shares from all over the world, weighted by their size. This means the index is dominated heavily by US shares, and, within that, US tech shares. The V in 2020 is clear

The precipitous plummet of share values in March has been all but nullified by a recovery to levels that have prevailed for the last 2.5 years. So, it’s back to the races for world stock markets?

How did this occur in an environment of social and racial unrest, volatility in policy, economic uncertainty and burgeoning unemployment?

Developed countries have thrown a ridiculous amount of money at the problems caused by the virus. US citizens with bank accounts were simply given a deposit straight into their accounts, unemployed US citizens were also gifted an extra unemployment benefit, UK citizens who had been laid off or asked to work less for less pay were protected by a “furlough” scheme where a large proportion of their salaries continues to be paid by the government and many other developed countries adopted similar relief measures. Many US citizens have earned far more in COVID-19 unemployment benefits than they did before being asked to work fewer hours or take pay-cuts.

And in South Africa, without a government with deep pockets and a debt problem threatening to spiral out of control? A seemingly similar story in the share market.

JSE All Share Total Return

Source: iGraph

The All Share Index (including dividends) has also recovered to the higher level of the range in which it has been trading for the last 3 years or so. Of course, more than half of the JSE is not South African shares at all. The largest share, Naspers, is actually a Chinese on-line gaming company as more than 100% of the value of the share is in a Chinese company called Tencent. The next largest share is British American Tobacco which derives a paltry proportion of its revenue from SA (none in lockdown!). The vast majority of its profits come from selling cigarettes (and e-cigarettes) across the globe. Add the diversified miners and gold and platinum companies, Sasol and a few others and the top 50% of the JSE is, in reality, developed market companies earning mostly US dollars.

Similarly, the top 50 shares in the S&P500 in the US comprise 90% of the market capitalisation of the entire index and it is only these shares that show a positive return for the first 6 months of 2020. The other 450 shares are in negative territory to 30 June.

So, how sound has the V been? When reality sets in, isn’t another crash likely perhaps followed by another recovery to make a W? Or will it stay down a while before recovering to make a U in the second leg. The low road scenario sketches an L where markets crash again, or at least correct dramatically, and the severity of the situation keeps markets down for a long while. And the final shape may be a correction followed by a long, slow, sober recovery in the shape of the Nike Swoosh.

What could dictate the shapes of things to come?

Of course, there are many factors, some more obvious than others. Amongst the obvious ones are the US election, relations between China and the US, resolution of Brexit, social unrest across the globe for a number of reasons, Chinese growth as a consumer nation and its influence on other Eastern countries and the progress and containment of the pandemic.

Perhaps a less obvious factor is the huge number of people who don’t yet know that they are unemployed. The artificiality of the colossal amounts of money thrown at temporary employment relief schemes and furlough arrangements has deluded millions of people into thinking they still have jobs. These schemes, after likely extensions in the US until after the election, will expire after which employers will have tough decisions to make about which employees they wish to keep if, indeed, they are going to re-open. The chart below shows that nearly 20% of the US workforce is currently claiming jobless benefits.

Week 18 of the collapse of the US Labor Market – total ‘continued claims’, State & Federal

Source: DOL

Most employers have discovered that they can do quite nicely with fewer employees, less space and lower costs. When the government funding runs out, millions of people around the world are going to discover that they are surplus to requirements with no job and no government scheme to help them.

Add a few more sobering facts:

  1. COVID infections are still climbing in the US and seemingly out of control in some epicentres.
  2. The effect of COVID in developing/emerging countries is starting to be felt only now.
  3. Many countries are experiencing either a second wave of infections or simply a continuation of an insufficiently suppressed first wave.
  4. The money thrown at the problem by developed countries will have to be paid back some day.

And it becomes clear that the economic woes of the world are not over. There will continue to be challenges to governments, companies with high debts, travel and hospitality industries and overburdened healthcare. These challenges will prevail well into 2021.

However, there will be companies that thrive in such an environment. Companies with entrenched market leadership by themselves or with few others, companies that generate cash not profits, companies with little to no debt, companies with the entrepreneurship to re-invent themselves to benefit from the circumstances, companies with strong brands and loyal customers will thrive and will command a premium price to own. So, expect these companies to trade at stretched prices for a while – their earnings support the prices.

Investors will need to ferret out the asset managers who are capable of finding these companies – there are many outside of the realm of the household brand names. Managers which mask closet index adherence behind an active label will be punished.

For amateur investors, investment advice has never been so critical. It is entirely possible that market-leading brand names will falter under the burden of size or reluctance to deviate from the index. Investment advisors worth their fees will be able to recommend the right asset managers to protect your retirement capital and savings and help them grow to fulfil your dreams.

So what does that mean for our portfolio construction?

Global equity – overweight

We prefer global equity to SA equity. It’s a crowded trade but the mantra is “Global for growth, SA for yield”. However, not indiscriminate or indexed global equity. Quality companies with definable moats which can generate cash without going into debt – not highly geared companies selling debt to buy back their own shares.

Global property – neutral to underweight

Again, selectively. Office space and retail will surely suffer but data and other forms of storage and high-tech industrial real estate will hold up.

Global fixed interest – underweight

Outside of emerging markets, fixed interest seems fixed at 0% so to be avoided, especially as some of it guarantees losses or negative interest rates.

Global cash – neutral to overweight

We will hold it for liquidity to enable us to buy the dips and capitalise on corrections.

SA equity – neutral to underweight

As we buy funds and not the equities themselves, we have to be careful to buy the portfolios with the right tilts. SA Inc shares – financials, retail, property-related and some industrials – are to be avoided. The Rand-hedges which are Dollar-earners but happen to be listed in Johannesburg will prosper even without a weakening Rand. Again, quality, low debt and cash-generative companies will be the shares we look for in a manager’s portfolio.

SA property – underweight

One or two companies may manage to keep value – the others are in trouble. High debt, dubious quality, intense pressure from faltering tenants all add up to a sorry sector.

SA fixed interest – overweight

Still overweight but it is becoming more challenging with 300 basis points of rate reductions this year. The returns are still optically providing real (greater than inflation) value but the margins are tighter and helped by a plunging inflation rate.

SA cash – neutral to overweight

We need a float to benefit from opportunities and it does still offer real rates of return.

Download: Q2 2020 review


The content of this article is for information purposes only and does not constitute an offer or invitation to any person. The opinions expressed are subject to change and are not to be interpreted as investment advice. You should consult an adviser who will be able to provide appropriate advice that is based on your specific needs and circumstances. The information and opinions contained herein have been compiled or arrived at from sources believed to be reliable and given in good faith, but no representation is made as to their accuracy, completeness or correctness.

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