BY Dwayne Dippenaar Portfolio Manager, Laurium Capital
As the old proverb goes, ‘The darkest hour is just before the dawn’, and the new year certainly brought with it what felt like a new dawn for South African markets. The FTSE-JSE All Share Index (ALSI) had an extremely strong start to the year, up +11.2% in USD for the first quarter of 2021, and helped along by a steady ZAR, outperformed the MSCI world (+4.5%) and MSCI EM (+1.9%) nicely. The adage from Warren Buffet to ‘be greedy when others are fearful’ could not have been illustrated better over the past year with the ALSI now up +75% (as at 31 March 2021) since its low point in March last year. In fact, the ALSI is now +16.5% above where it ended 2019, and has thus not only recovered from any COVID-19 impact, but provided investors with a decent return off pre-pandemic levels. Investors that were patient and able to stomach the volatility of last year have been well rewarded.
Many might look at the above returns and struggle to reconcile them with what is happening in the real economy, where we continue to face lockdowns, increasing job losses and still much uncertainty. The rapid recovery in financial markets and subsequent divergence from the high street can materially be attributed to what has been called the most generous action of all time from central banks and governments. In the US alone, the Federal Reserve expanded its balance sheet by over $2.7tn through bond buying, and the Treasury funded $4.5tn in grants and loans. These actions were echoed throughout the developed world, and all this money needed to find a home. A large part did so in the capital markets, driving asset prices higher, often beyond what seemed justified by fundamentals.
We entered 2021 with the tailwinds of global fiscal and monetary support, the global rollout of the vaccine and a recovery of the global economy off the low base set by the near economic standstill induced by the initial COVID-19 extreme lockdowns. We have seen these bullish dynamics play out in the first quarter, with strong data out of China supporting commodity prices, and the general reopening of economies as the vaccine gets rolled out, supporting stocks that benefit from an economic recovery.
Figure 1: Comparative blended 1-year forward PE multiples of MSCI South Africa and major global MSCI Indices
The big questions that we now must answer are around the sustainability of the economic recovery. What will be the effect of a third wave of COVID-19 (or even a fourth, if vaccine rollouts continue to be so slow)? What are the implications for inflation and for interest rates, given the massive fiscal and monetary stimulus? Lastly, and perhaps most importantly, what outcomes have been priced into the valuation of various assets globally? On this latter point, we believe that there are specific sectors and markets globally that are starting to look expensive, where the risk reward is no longer attractive. We are still finding pockets within the local and offshore markets that look very attractive and believe could still provide handsome returns to investors over time. Many South African focused companies, for instance, still look attractively valued when examining a simple index of the one-year forward PE of companies that are most exposed to South Africa (SA Inc.). SA Inc. is trading one standard deviation cheaper than its seven-year history.
We note that the MSCI SA index is also trading at a large discount compared to other global markets forward PEs, including other emerging markets that are trading at a 15x forward PE.
Our Laurium Capital funds are well positioned to take advantage of these opportunities. Being a small and nimble boutique manager, we are able to invest in the broader South African universe efficiently, implementing our best ideas in high conviction positions across the portfolios.