The last month has seen the most brutal stock market crash that most investors have experienced. Since 18 February this year, the FTSE JSE All Share Index has declined by 35%. In comparison, the 2008 crash saw a 41% drop over nine months of extended hell. So, is it time to buy the crash? It’s brave and perhaps a little foolhardy to make any predictions amid the current madness but, for investors who can stomach further volatility, some once-in-a-lifetime buying opportunities are surfacing. Of course, it can get worse before it gets better, but unfortunately nobody is clever enough to time the exact bottom.
Importantly, and as Figure 1 below shows, the market always recovers. Even if there was another 10% drop, eventually markets snap back and capitulating now is, in all probability, exactly the wrong thing to do.
Figure 1: The FTSE JSE All Share Index performance, 2000 to date
Source: Bloomberg, Anchor
Wednesday (18 March) was particularly devastating on the JSE, with many share prices of credible companies falling by 10%-30%. This was particularly painful in the banking and property sectors and in those shares where the market is questioning whether balance sheets are strong enough to weather the current storm. On the day, some of the big movers were Nepi Rockcastle (-30%), FirstRand (-15%), Absa (-12%), Bidcorp (-13%), Impala Platinum (-24%), MTN (-13%), PSG (-26%) and Redefine (-20%). Devastating.
It seems very unlikely that these price drops are justified, and many shares are pricing-in Armageddon. While the 2008 crash was started by toxic lending in big global banks, this time around it’s about an expected sharp drop in demand due to COVID-19 fears and consumer hibernation. For many companies, this sharp drop in turnover will lead to losses and, for those that started the crisis overgeared, there can be a permanent loss of value (by having to have rights issues or having to sell their crown jewels at the wrong time). Some companies will face bankruptcy, and this is where authorities are stepping in to provide support.
Share prices are beginning to factor in the global consumer freeze lasting a very, very long time. Nevertheless, this will pass and things will return to normal, but the big question is when? If global trends follow China and the rate of infections slows due to “social distancing” and other measures, this will signal the start of a return to normality.
Figure 2 below shows the current and expected drop in sales for global retailers:
Figure 2: Ghost Malls: Sales are set to fall sharply as retailers close stores (%)
Source: SW Retail Advisors
Note that Q1 and Q2 are maximum estimated fall.
However, in this article we are focussing on SA shares. The 35% drop in the SA market is particularly severe for two reasons – first, the market has gone sideways for five years and the starting point was already cheap; and second, the rand has weakened by 18% YTD against the US dollar and about half of company earnings on the JSE are not rand-denominated. In comparison, the 31% drop in the S&P was from a high starting point at the beginning of the year (where returns last year were close to 30%).
In attempting to identify good entry points for SA shares, we have separated the opportunities into two categories. We certainly believe that investors should be focussed on quality companies and should emerge from this market move invested in the best companies.
Lower risk, with balance sheets to survive a period of low demand
These shares have typically not fallen as much, but many of them offer substantial returns when the world starts to return to normal.
Shares of companies with higher levels of operational or balance sheet risk, but we think will handle a reasonable period of disruption
These shares have more upside than the first category, but need to be carefully monitored on an ongoing basis.
Figure 3: Property shares
Source: Bloomberg, Anchor
It is clear to us that there are currently very attractive entry points into quality businesses on the market. These businesses could very well get cheaper still, but we believe that in SA we have reached the point of starting to deploy new capital in a measured fashion.
Global markets are reacting to the COVID-19 virus far quicker and harsher than we could have imagined in our worst nightmares. While this started as an equity sell-off in the US, it quickly became a liquidity squeeze that has seen the US Federal Reserve institute over $1trn in emergency liquidity lines to US financial institutions. Unfortunately, getting the cash from banks, that can access the liquidity lines, to market participants that are facing margin calls and investor redemptions is not that easy. For now, it seems that the liquidity pressures in the US are abating. At the time of a margin call you sell what you can to meet the margin requirement. That means US treasuries, which is why US yields have started to push higher. You also sell riskier investments, where you can find an exit. The SA bond markets are some of the most liquid and developed in emerging markets (EMs) and, as a result, we have seen investors selling over R45bn of local bonds. This is an incredible volume of bonds for the SA markets to absorb in a mere two weeks. Market makers are obliged to show prices for the bonds and, at a time of desperate sellers, it doesn’t matter how ridiculous the price, the bonds are being sold.
The market has completely lost sight of fundamentals as the flow of bonds keeps driving bond prices lower. At one stage on Wednesday, six-year government bonds were trading at a yield of 11%. That is the equivalent of CPI plus 6.5% from a six-year government bond. This is even more ridiculous when you consider that SA fuel prices and CPI are set to drop significantly from next month. Only two short weeks ago, clients were asking how they could earn a guaranteed income of 10%. Now the government will guarantee you a return of up to 11% for six-year investments. We find this to be an incredibly attractive opportunity to lock-in high yields at a low risk for clients and we have been gradually increasing our exposure to government bonds. We are doing this in a staged and measured process over time as yields have been getting ever more attractive in the last few weeks. We do not expect this opportunity to persist for too long and we believe that fundamentals will again dominate once the forced selling out of the US stops. Until then, we expect bond prices to remain under pressure thus giving us an opportunity to really lock into the attractive guaranteed returns currently on offer.