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STRAT DOC 2Q18 – THE ANXIETY OF EQUITY MARKETS

11 April 2018

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by Peter Armitage

We might be able to do a mean spreadsheet, but that does not mean we are definitely going to make you money right now. That’s because the market does not know about our spreadsheets and often the value that we calculate for a company is very different from where a share trades – at least in the short term.

This is one of the factors that often makes our jobs incredibly frustrating, but equally fascinating. There are many dynamics that influence a share price and varied skills that are required to “make the right call”. In order to invest on the stock market, at the very least, you should be smart, analytical, balanced, intuitive and, most importantly, patient. And a little bit of luck also helps at times!

As custodians of people’s wealth, our primary mission is to make money (with the appropriate risk etc.). We wake up in the morning thinking about shares and we spend most of our day digging through information and vigorously debating economics and companies. Nothing brings us greater joy than seeing a share price rise and nothing makes us more anxious than a plummeting counter or simply not delivering the returns that we would expect as a client.

There are times when it just seems easy and the runs flow and then there are times when it’s just downright difficult. That’s the story of the market over the last few years. An equally weighted FTSE JSE Top-40 portfolio has now been flat for three years and the FTSE JSE All Share Index return over the same period has been a paltry 5% p.a. It’s not a disaster, but it’s just plain boring. However, this is exactly when we shift up a gear and our collective skills and experience become critically important.

So how do we respond?

First, with the understanding of context. In a 24-year career, I have personally been through several periods of equity market fatigue. It was never right to lose faith in the market. Staying invested and being in the right shares always delivers a great return over time. I always get reminded of that when I look at older share portfolios and observe the value created by owning a growing company over time. Over the last 15 years, JSE investors have, on average, made 17.5% p.a. (that’s a 1,000% return!) and many great companies have delivered much more than that. I remember writing a report on Naspers at R16/share and Capitec at R20/share. This is the place to make money. It sounds simplistic, but the longer the market goes sideways or down, the better the chance of a great future return.

Second, we respond with passion. There are always ten shares that are going to give you an outsized return over the next year and it is our job to find them. Our analyst team hits the road and visits swathes of companies, digests the analysis and finds future gems. Opportunities are created by the performance of a company or the mispricing of a share. When the market has been moving strongly upwards it is often harder to find the latter. Equity investment is the world we choose to live in and we love what we do.

Third, we respond with patience and sticking to the plan. As we indicated earlier, shares don’t always move logically and often returns come when you least expect them – nobody has the ability to predict exactly when returns will materialise. Our philosophy is to invest in companies that are growing and that can reinvest capital at a high return, generated in cash. If we can find these companies and identify appropriate entry prices, the underlying value of your investment will go up every year. Share prices sometimes run ahead of this underlying value and sometimes they lag but, over time, share prices follow earnings.

Fourth, we respond with a level head. We don’t panic, and we always bear fundamentals in mind. Knee-jerk reactions are usually wrong. We also seek opportunities where sentiment and emotion depress prices

It’s also worth putting into context the performance of the market over the last year or so. There are two important drivers of the SA market – Naspers (given its weighting in the overall index) and the currency, especially since c. 50% of SA earnings are generated in currencies other than the rand. Running into the end of 2017, local economic prospects looked dire and SA Inc. shares were battling – the biggest positive drivers of the market were Naspers and the weaker rand. With a reversal of the Zuma economic drag as a result of Cyril Ramaphosa’s victory at the ANC elective conference in December 2017, the currency has strengthened remarkably – from over R14.50/$1 to levels well below R12/$1. This resulted in a reversal of 2017 conditions. SA Inc. shares have performed very well, but this has been more than offset by the negative moves in Naspers and rand-hedge shares. A perfect storm, in a sense, with the negatives outweighing the positives in both instances, with a muted aggregate outcome.

However, nothing lasts forever and we know that the currency will weaken over time and that prospects for SA companies have improved markedly, with the risk being the time it takes for this to materialise.

So, we will carry on doing our spreadsheets and keeping a keen eye on fundamentals, which enables us to invest with conviction. And we will apply an overlay of the other skills we have learnt over time. A healthy dose of anxiety is also not a bad thing. But most of all we will be patient and the returns will come. Our SA equity fund has now compounded at around 15% p.a. since its inception just over five years ago, but recent returns have been more muted. We are working hard to try and repeat that performance over the next five years.

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